What Makes up My Mortgage Payment?
After weeks of browsing house hunting websites, driving neighborhoods, and touring a few select open houses, you’re ready to buy your dream home. Unless you plan on paying cash, you’ll likely need a home loan. As long as you can find a mortgage with payments that don’t exceed your monthly budget, any loan will do, right? Maybe not.
If you have other long-term financial goals, such as a comfortable retirement, learning what makes up your mortgage payment is crucial to selecting the right mortgage loan for your finances.
Main Components of a Mortgage Payment
Financial jargon can be confusing. In frustration, some homebuyers might even dismiss specific acronyms as unimportant in their eagerness to grab hold of the keys to their new home. But, there’s at least one financial term that you shouldn’t ignore, no matter how strange it sounds – P.I.T.I. The term refers to the main elements of a mortgage payment.
Let’s examine how each letter influences your overall payment.
P = Principal
One of the main reasons to make a substantial down payment on your new home is to reduce the principal amount of the mortgage payment. The larger the down payment, the less you must borrow. For example, if you put a 20% down payment on a $200,000 home, you’ll only need to borrow $160,000, which is your principal amount. All mortgage loans start with a principal amount to which interest is added.
I = Interest
The cost of borrowing money is usually paid in interest charges. Securing a low-interest rate home loan directly influences your monthly payment amount and also how much of the payment applies to the principal. For example, a 30-year fixed-rate loan at 2.75% interest rate might require a monthly payment of $40.82 per $10,000 borrowed. The same mortgage at a 3.0% rate may cost $42.16 per $10,000 borrowed. A loan’s amortization schedule will reflect how much of your mortgage payment applies to the principal balance each month. When you make payments on your loan, most of it will initially go toward interest. Gradually, more of each payment will be applied toward the principal balance until the loan is paid in full.
T = Taxes
For some homebuyers, the mortgage payment is a simple principal plus interest calculation. For many others, the monthly mortgage payment will add in escrow payments, which are collected to cover annual property taxes. Lenders work with borrowers at the time of closing to set up an escrow account. This account holds funds that exceed the designated principal and interest payment amounts.
Property taxes, which are based on your home’s local assessed value, help pay for public services, such as police, roads, firefighters, and schools. The estimated annual tax amount is divided by 12 (the number of months in a calendar year) to determine your monthly payment.
I = Insurance
If you’ve ever had optional renter’s insurance, you understand the need to protect your possessions. But, when you buy a home, the homeowner’s insurance isn’t optional. Mortgage lenders require it. They want to ensure their investment is fully covered in the case of a catastrophic event, such as a fire or tornado.
Similar to taxes, your annual insurance premium is added on top of your regular principal and interest payment each month and placed in an escrow account. An escrow company is responsible for ensuring the amount deposited is paid to your local government in the case of property taxes and an insurance company when due.
Putting less than 20% down on your new home requires payment of another type of insurance, Private Mortgage Insurance (PMI). It protects a conventional mortgage lender if the borrower defaults on their mortgage payments. The cost will vary by lender but may be between 0.17 and 1.5 percent of the principal home loan. You may remove the PMI from your loan once you have 20% equity in your home.
Note: If your new home is in an area that requires Homeowner’s Association (HOA) fees, you may be able to add these to your monthly mortgage payment. Just as with taxes and insurance, the escrow company would pay the HOA fees when due.
Contact an ENB Mortgage Expert to learn more about selecting a home loan that’s a match for your budget and your financial goals.