A Simple Guide to Mortgage Payments

Buying a home is one of the largest and most important financial transactions most people will make in a lifetime. A mortgage loan allows a homeowner to pay off the purchase over time, typically 30 years. Calculating how much your monthly mortgage payment will be on a new home can be a complex process, since multiple factors are taken into consideration. After all, mortgage payments work differently from paying monthly rent on a piece of property.

Understanding the structure of a mortgage payment is key to getting a handle on exactly how much you’ll pay each month toward the purchase of your home, where the money goes, and how long you’ll make payments. To that end, here’s a look at the anatomy of a mortgage payment, including a detailed breakdown of its four main components: principal, interest, taxes, and insurance – or PITI, for short.

Most people who are shopping for a new home don’t have enough cash on hand to purchase the home outright, so they apply for a mortgage, which is a long-term loan on a piece of real estate.

Mortgage payments are derived from the total amount of the loan, which generally covers the purchase price of the property minus the down payment. When you make a mortgage payment to a bank, credit union, or other lender, your payment will often incorporate the principal, interest, taxes, and homeowners insurance, plus, in some cases, private mortgage insurance or homeowners’ association or condominium fees. Most homeowners make mortgage payments on a monthly basis for years, until they eventually pay off their loans.

When calculating an estimated mortgage payment, your lender will take four factors into consideration: the principal, interest, taxes, and insurance (PITI) on a piece of property. Here’s a closer look at each of these components:

• Principal: The principal is the amount of money originally borrowed when taking out a loan. When making a monthly mortgage payment, a portion of that payment is applied toward paying off that principal to reduce the total mortgage balance. In most cases, mortgages are structured so that the portion that goes toward your principal starts out low and gradually increases over time.

• Interest: In exchange for providing the loan, lenders charge interest on a mortgage, which is expressed as a percentage of the total purchase price. When making a mortgage payment, the portion that goes toward interest starts out high and gradually lowers over time. As you pay down the principal and the principal balance decreases, you will owe less interest each month and more of your monthly payment will be applied toward paying down that principal.

• Taxes: State and local governments charge property taxes on a home, and this money is used to help pay for public services, including a community’s schools, police officers, firefighters, and public works departments. The government calculates the property tax rate on a yearly basis, and the amount you pay depends on the assessed value of your home. If a home’s assessed value rises over time, the property taxes increase as well.

Many homeowners divide the total annual property taxes into a monthly amount that they roll into their mortgage payments. Lenders then hold the money in escrow until the taxes are due, often on a quarterly basis.

• Insurance: Lenders typically require homebuyers to purchase homeowners insurance, which protects the property against fire, theft, and natural disasters like hurricanes and tornadoes. If a home sustains damage, this insurance is intended to cover the cost of repairs, restoring the property’s value. A second type of insurance that may be required of some borrowers is mortgage insurance. For instance, borrowers with a conventional mortgage are required to pay private mortgage insurance (PMI) if they buy a home with a down payment that is less than 20% of the purchase price.

Similar to how they handle taxes, homeowners often roll insurance costs into their mortgage payment. The money is held in escrow until needed to pay the insurance bill when it’s due.

Here’s a hypothetical example to show how a mortgage might be calculated.

Jane has a 30-year mortgage with a principal of $200,000 and a fixed interest rate of 4.15%. She pays no PMI because her initial down payment was more than 20% of the home value.

• Combined, the principal and interest portion of her monthly mortgage payment is $975 per month.
• Her property taxes are $4,800 per year, or $400 per month.
• Her annual homeowners insurance premium is $1,680 per year, or $140 per month.

So, Jane’s monthly mortgage payment is $1,515 ($975 + $400 + $140).

When weighing the pros and cons of different mortgage offers, you may want to carefully consider the interest rate, since a home loan with a higher interest rate will increase the mortgage payment. Rates vary depending on the length of the loan, and the interest rate may be structured in two main ways: as a fixed rate or as an adjustable rate.

• Fixed-rate mortgages. With a fixed-rate mortgage, your interest rate will remain the same for the life of the loan, which means your monthly principal and interest payment will not change over time.

• Adjustable-rate mortgages. If you opt for an adjustable-rate mortgage (ARM), your interest rate may change over time. In many cases, ARMs start with an attractive low-interest rate for a specified period of time; but once that period is up, the interest rate could change. ARM rates are typically tied to a benchmark rate that rises and falls based on market conditions, so they are adjusted periodically – typically, every six months. If the rate rises, your monthly principal and interest payment would increase.

Most homebuyers choose fixed-rate mortgages because the mortgage payment is more predictable over the long term, according to the Consumer Financial Protection Bureau.¹