Rent payments tend to be fairly straight forward in how that money is applied regarding the contract you signed. Mortgage payments are a bit more complicated, as they are made up of several different parts that your money is applied to. Naturally, most people are curious about what those different components are and how things like interest are calculated.
Understanding how it all works is an important step in figuring out how long it will take you to pay off your loan and just how much it is going to end up costing you in the end.
What Exactly is a Mortgage Payment?
The first thing you need to understand is just what exactly your mortgage payment is. Simply put, this is how you pay back the loan you signed when you purchased your home. Typically, this is a monthly payment made by you that slowly pays down the large sum of money that you borrowed. It also includes additional costs such as interest, taxes, and insurances. A mortgage loan, made in installment payments like this, is how most people are able to afford to purchase a property that comes with such a high price tag.
There are mortgage calculators online that will show you how it all works out once you enter in your loan amount and the term of your mortgage. But let’s break it down into digestable pieces right here, shall we?
Principal
A basic mortgage installment is made up of two components – the principal and interest. The principal is the total amount of the actual loan that you initially borrowed from the lender. This is calculated out over the life of the loan and you make a monthly payment towards that total. Typically, the amount of your monthly payment that is applied to the principal is relatively low. As time goes on, and the loan ages, that percentage gradually increases.
Interest
The second component included in a basic mortgage payment is the interest. This is the fee that you pay to the mortgage company for them lending you the money. This percentage of the total loan is likewise applied to your monthly payments as you repay it a little at a time. The amount of your payment that is applied towards the interest decreases as the loan ages. You might also have the option to claim a mortgage interest deduction on your taxes each year, further offsetting the interest that you owe.
It should be stated that a fixed-rate mortgage will not see a decrease in the interest that is paid each month. For the entire life of the loan, no matter how the real estate market fluctuates, the percentage that you pay will remain the same.
Taxes
Regardless of where you call home, you will have to pay property taxes on your home. How much you pay, on the other hand, is based on a percentage of what that property is valued at and what the local tax rates are. Usually, this amount changes every year. Every county has its own system for determining property taxes. If the assessed value of your home increases (this is independent of the market value), then your property taxes will increase along with it.
In many cases, the property tax payments are escrowed into your monthly mortgage payments, with the amount that you owe for the year being calculated out over that many installments. However, if you were able to offer more than 20% of the total purchase price of the home as a down payment, you usually have the ability to opt out of escrowing this payment if you want. Even if this option is available to you, you may want to consider having it figured into your mortgage payments anyways.
Insurance
Insurance is another cost that might be escrowed into your mortgage payments. Again, this is typically determined by whether or not you were able to put enough money towards a down payment to owe less than 80% of the total loan. Usually, the insurance you will have to pay will fall into one of these two categories:
- Homeowners Insurance: This type of insurance protects your home and finances in the event that a natural disaster or accident happens on your property. If such an event were to occur, your homeowners insurance would usually go towards covering the cost of any repairs incurred.
- Mortgage Insurance: If you were unable to pay 20% or more as a down payment when you purchased your home, then you mave have had to pay a premium. Or you may be required to carry some type of mortgage insurance to cover the investment if you default on your loan. The higher your loan-to-value ratio (or the closer the loan amount is to the total cost of the home), the bigger the risk to the lender. Depending on your loan, you may have to pay private mortgage insurance or a mortgage insurance premium.
Ways to Lower Your Payments
If you are able to do so, paying extra towards your principal can save you a lot of money over the life of the loan. Pay just a little extra each monh or make a single extra payment at some point during the year (such as when you get a bonus or your tax return). This practice can help you pay off your mortgage early, build equity, and save money on your interest payments. Check with your lender to see if there is a prepayment penalty on your loan before you make this decision.
Once your home’s loan-to-value ratio has dropped below 80% of its total cost, your private mortgage insurance is usually no longer required. According to law, this must be removed once the LTV reaches 78%.
As with any advice regarding a mortgage loan and what payments will be included, it is best to check with your individual lender. Mortgage contracts are as varied as the homes that they cover, so you should always familiarize yourself with the details contained within your agreement. If you are unclear or feel apprehensive, you should consult your real estate agent or consider hiring a real estate attorney to help you navigate the terms of your contract.