How is Your Mortgage Payment Calculated?
If you’re thinking about buying a home, getting preapproved for a mortgage is one of the first steps you’ll likely take. In fact, 87% of buyers took out a mortgage to finance their home purchases in 2020.
Understanding how a mortgage payment is calculated, however, is not only important from a budgeting perspective — but it can also help you shop for the best rates and terms for your situation.
Breaking Down Your Mortgage Payment
A mortgage is composed of four items: the principal, interest, taxes, and insurance. Collectively, these costs are referred to as PITI. These four elements are determined by internal and external conditions, such as your own credit score and the greater real estate market . Small changes can make a substantial difference to the final loan you’re offered.
Understanding the individual components that make up your mortgage payment and how changes impact your loan can help you navigate your purchase.
#1. The Principal
The principal is the mortgage’s foundation. It is the amount of money you’re borrowing to buy the home. If you’re planning on purchasing a home at 2021’s average listing price of $329,100, and you intend to put 10% down, your mortgage principal is $269,190 — the cost of your home minus the down payment.
Your payments will be applied mainly toward your interest at the start of your mortgage. However, as your loan matures, more of your payment will be applied to the principal.
#2. Interest
Your lender charges interest on the money you borrow. This is one of the ways they manage risk — with the lowest rates only available to those with exceptional credit and a low debt-to-income ratio. Although mortgage rates are currently at all-time lows, the rate you are offered will be based on your specific financial situation.
Because rates vary from lender to lender, borrowers need to shop their mortgage terms before purchasing a home.
You may also be able to reduce your interest rate by purchasing mortgage points. Typically, one point costs 1% of your loan amount. The home buyer can purchase mortgage points — but they can also be worked into the deal and paid by the seller or even the lender. If you’re not offered an interest rate that you like, talk to your lender to see if this option is available.
#3. Taxes
In addition to your mortgage principal and interest, property taxes are collected from your monthly payment and are held in an escrow account. When your property taxes are due — the bill will be paid from your escrow account on your behalf.
The amount of property tax you pay is determined by the tax rate set by your local government and the value of your home (including the land it sits on). Most home search websites show you the property taxes for each listing so you can have an idea of the cost before buying the home. You can also understand the property taxes by contacting your local tax commissioner’s office.
#4. Insurance
Referred to as PMI, private mortgage insurance is required on loans when less than 20% is put down. If you default on the loan, PMI covers the lender for that loss. Since the average down payment in 2020 was 6%, most mortgages include PMI.
Mortgage insurance payment amounts are based on the loan’s principal and are included in every month’s mortgage bill. For a conventional loan, PMI can range from 0.5% to 2% of the loan amount.
Lenders also want to know that you have homeowner’s insurance. As a result, most lenders bundle a homeowner’s insurance policy into the monthly payment amount.
Similar to property taxes, your lender will collect your insurance payments and hold them in an escrow account. When the bill is due, your lender will pay for your policy using the funds that have been set aside in your escrow account.
How the Loan Term Impacts Your Payment
The loan’s term divides the lump sum of your mortgage into manageable monthly payments. Typically, loan repayment periods on a mortgage are 15 years or 30 years. The mortgage term you choose will determine not only how long you’re paying off your home, but also the total amount owed on your loan.
For example, a $250,000 loan with a 4% interest rate over 30-years costs $429,677 with $179,677 in interest. The same loan with a 15-year term costs $332,866 with $82,866 accumulated interest. There are pros and cons to each option, so borrowers should make the decision that best fits their personal circumstances.
Utilize a Mortgage Payment Calculator
A mortgage payment calculator is a great tool if you are trying to learn more about how your monthly payment is calculated. By inputting a few variables — such as your principal, interest, taxes, and insurance — the calculator can help you determine what your monthly payment might be. Of course, it is always best to speak with your lender to understand the specifics of your particular situation.
For more helpful mortgage tips, see what our real estate blog has to offer.
