Breaking Down a Typical Mortgage Payment
What makes up a mortgage payment can become complicated, regardless of whether you are a new or seasoned homeowner. It’s okay if you just want to know the monthly amount you owe and not delve too deep into the financial concepts. For those of you who want a few more details, it’s important to understand exactly how mortgage loans breakdown as a consumer.
If you've ever heard your loan officer mention something called a "pity payment" and scratched your head trying to figure out where the need for "pity" came into the equation, you're not alone. What they were really saying was "PITI," and they were talking about Principal, Interest, Taxes and Insurance, which are the four main components that make up a typical monthly mortgage payment.
While PITI is the typical, and commonly assumed makeup of a mortgage payment, some loan programs could include other elements. Based on your property and loan type, your monthly payment may also include mortgage insurance. For the most part, though, PITI is what you'll be looking at when planning your mortgage and the monthly payments to come.
Let's take a look at a typical PITI monthly payment breakdown:
PRINCIPAL: The principal is the amount that pays back and reduces the mortgage loan balance. As time passes, the amount you pay in principal each month will increase as the interest amount decreases.
INTEREST: Interest is the ongoing cost of borrowing the money in a mortgage loan. As time passes, the amount you pay in interest each month will decrease while the principal amount increases.
TAXES: Real estate or property tax amounts are decided through your property assessment. The taxes due for your property will be the same amount regardless of the size of your mortgage. The tax portion of your mortgage payment is typically held in an escrow account that makes sure your taxes are paid on time.
INSURANCE: Homeowners or hazard insurance amounts are decided by the coverage plan you choose with your insurance company. This part of the mortgage payment is not affected by the size of your mortgage. Insurance payments are typically held in an escrow account that makes sure your insurance is paid on time. Some loan programs also have mortgage insurance, which is affected by the size of your mortgage. Mortgage insurance is insurance for the lender, should you default on (stop paying) your debt obligation.
For more information, check out this article.
Things to Know
There are other calculations and fees that will impact your monthly amount due when figuring out your mortgage and the financial responsibilities it requires.
Loan Amortization Calculator
This is referred to above in the principal and interest section. Over time the mortgage loan is amortized, which means the mortgage debt is gradually reduced over the loan term, taking interest into account. Each month your mortgage payment has a portion that goes toward principal and a portion towards interest. In the beginning most of your payment is going towards your interest and when you are reaching the end of your mortgage, you will be paying more principal. You can plug in your numbers into this amortization calculator to see how your allocations change over time with regards to principal and interest.
Private mortgage insurance, also known as MI, is to ensure the lender is protected. No, 20% is not needed for a down payment on a home, but typically if your down payment is less than 20%, you will also need to get mortgage insurance. Although it does make homeownership within reach for some who do not have the 20%, it also increases your monthly payments. Mortgage insurance will be a percentage of your principal and is typically paid monthly, but there are other options. Take a more detailed look at MI here. (can link out to new one once published)
Homeowners Association Fees (HOA)
Although not part of your mortgage payment, it could be an added financial obligation, depending on where you decide to call home. An HOA fee is typically associated with a community. It will go toward any shared facilities and property ground maintenance. Depending on the size and quality of your community, this may add a substantial amount to your overall housing costs.
Why Understanding This is Important
It's good to understand how this all comes together when you're considering how much you can afford and, if hunting for a new home, where you want to search. For more peace of mind, read up on how you can plan for extra home expenses.
Imagine this scenario: You are pre-approved for a mortgage, the monthly payments are within your budget, and all you must do is find the perfect home. You find that home, go back to your loan officer, and find that the monthly payments suddenly jumped up past your comfort level. What happened? Is your loan officer playing tricks?
Not at all. If you had been paying attention to property taxes while you were doing your home search you may have noticed that the property taxes on this must-have home were significantly higher than what had been estimated. Loan officers generally make it their business to get those estimations as close to local averages as possible, but it can happen that a certain municipality happens to have a higher rate than the others around it. The same can happen with homeowners' insurance. Not all insurance companies have the same prices, and each property and situation will be just a little different. Your loan officer will do their best at estimating during your pre-qualification, but until you have those real numbers it's just a "best guess."
Bring Your Questions
It may seem like a lot to keep track of, but don’t let that deter you from finding your dream home in a price range you can afford. You'll be happy to know that you have allies. Your RMS Loan Officer should be able to help you with any questions you have and supply you with information that you can read over at your pace. If you're working with a real estate agent and an insurance agent, they should be valuable resources for your questions as well. All these professionals have made it their business to know this stuff inside and out, and they're there to help you. Bring your questions.
And now, knowing what you do, you can tackle this mortgage planning stuff with full awareness of how each of these pieces fit into your overall monthly payment picture. There's no need for pity here. Just some good old-fashioned self-confidence, knowing that you've got this.