What’s in a Mortgage Loan Payment

A monthly mortgage payment is made up of many different elements.  When you write your monthly mortgage check, you aren’t just paying toward the principal of your loan.  The monthly mortgage payment is also paying interest, taxes, insurance, and possibly other fees.  Before we look at the components of a mortgage loan payment let us review the components of the home loan first.

The home loan starts with the principal amount of the loan.  The sum of money you initially borrow is the principal balance.  Now you look at how long you will have to repay the loan, this is the term.  The term of the loan is its duration or the length of time for repayment.  Which brings us to the next key term, interest.  The interest rate is the mortgage rate at which the lending institution charges you for borrowing the money.  Once we have the basics of the interest rate charged, principal balance borrowed and the length or term of the loan we can calculate the monthly mortgage payments. 

Amortization is a lending term used to define the repayment of a debt over time.  In the early stages of a loan most of the payment will go towards paying the interest on the home loan.  In the later life of the loan the monthly payment goes more towards reducing the principal balance.  A mortgage’s amortization schedule can provide a detailed look at precisely what portion of each monthly mortgage payment is dedicated to each component of principal and interest.

Let’s take a look at the components of a house payment, and see where your money goes each month.

Principal and Interest Payment – This payment goes towards paying off the loan amount, or principal, and the interest that has accrued over the time period of the loan. You can use a mortgage loan calculator to help you determine possible P&I payment amounts as you consider a loan.  You an also look at how much interest and principal repayment you will have over the life of the loan.

Real Estate Taxes – Your mortgage payment will also include one twelfth of the annual real estate taxes each month.  Real estate taxes are calculated by the local government taxing authority, not the mortgage company, the lender collects the payments and holds them until the taxes are due to be paid.  Lenders pass these taxes on to you monthly, because if they are not paid, the government can have a lien placed against the house.  If the owner of the home fails to pay real estate taxes, the government can sell the property in order to collect back taxes.  Escrowing these taxes ensures the mortgage lender that they will be paid.

Homeowners’ Insurance – Most mortgage lenders require a homeowners insurance policy for at least the amount of the home itself.  The mortgage company often require that the first year of homeowner’s insurance be paid in full at closing.  The mortgage company then continually stays ahead on the premium by escrowing 1/12 of the insurance payment with the monthly mortgage payment, which eliminates lapses in coverage on the part of the homeowner.  Note that having only enough coverage to cover the value of the mortgage only protects the lender’s interests should the home burn or fall to some other catastrophe.

Private Mortgage Insurance Escrow – If the loan has a loan to value ratio of over 80%, this mortgage insurance covers the lender in case the mortgage holder defaults on the loan.  If a down payment of 20% or more is put down, then this is not required.  PMI coverage may be dropped once the value of the loan is at or under 80% loan to value.  The mortgage insurance costs can be paid in a variety of methods including lender paid insurance in which there is an increase in the interest rate to cover the mortgage lenders cost.  The lower the down payment, the greater the loan risk and the more expensive the mortgage insurance will be.

Homeowner’s Association Fees – If homeowner’s association fees are mandatory, than one twelfth of these fees may be added to the monthly mortgage payment.  The process of adding homeowner’s association fees to the monthly payment is becoming very uncommon and the responsibility for the payment rests solely with the homeowner.

While principal, interest, taxes and insurance comprise a typical mortgage payment, some borrowers opt for mortgages that do not include taxes or insurance as part of the monthly payment.  With this type of loan payment, referred to as waiving escrows, borrowers have a lower monthly payment, but must pay the taxes and insurance on their own.