Adulting is hard. And nothing is more adult than making a mortgage payment. On the buyers section of our website, we have explained what a mortgage is: a financial instrument designed to fund the money required to buy a home, to be paid off over a long term with relatively low interest. The point of the mortgage is to help ordinary folks (people who don’t have $300k in cash sitting around) buy a home now.
What can get a little confusing is what’s actually in a mortgage payment, and so, spoiler alert – we do that here in this post. Let’s dive in.
Principal and Interest
A mortgage payment primarily consists of monthly installments that pays down interest and principal loan balance. The mortgage is structured so that much of the interest is paid in the beginning of the loan term, with more of the principal paid towards the end of the loan term. That’s called amortization.
Let’s say you have a $300,000 loan on a 30-year schedule at 4% interest. Your monthly payment is $1,432. The interest portion of your first payment will be about $1,000, with the remaining $432 going towards principal balance. At the end of your first year, you will have paid about $11,904 in interest, and $5,283 in principal. By the end of the fifth year, you will have paid $10,989 in interest, and $6,198 in principal.
That amortization continues right through to your final year’s payment, when your interest paid that year will be $367, while the remaining $16,820 of your payment goes towards principal.
If that sounds like a whole lot of money, it is – but remember, you are borrowing $300,000 from a bank. The way they protect their investment into you and your home is with interest.
One way to soften the bite of amortization over the life of your loan is to shorten the loan term. A 25-year, 20-year, or even 15-year loan can be acquired, which significantly reduces the total interest paid over the life of the loan.
Mortgage Insurance Premium (PMI)
If you have an FHA loan or a conventional loan with less than 20% equity in the home at the time of purchase, you may be required to pay Mortgage Insurance Premium, sometimes called PMI or MPI. This is an insurance policy that the bank takes out that protects their money if you suddenly default on your mortgage. You pay for this insurance, and the bank automatically bundles this into the mortgage payment.
The premium for this insurance usually runs around $100 – $150 a month, depending on the size of your loan, and it lasts for some pre-determined number of years, or until you have 80% equity in your home, whichever happens first.
The good news is that you can get PMI removed from your loan any time you think you have 80% equity built up. You will need to pay for a new home appraisal, which provides a professional opinion as to the value of the home. Give that to your lender, and request a review of your PMI. If your loan-to-value ratio is 80% or less, the insurance and premium is removed!
Escrow for Insurance and Taxes
Also included in a mortgage payment is a deposit that is held in escrow, which is a fancy name for a bank account that is held in trust on your behalf. This money is then used to pay for things like home insurance and taxes. Depending on where you live, that extra payment can be another couple hundred more attached to your mortgage payment.
The bank collects this money in the mortgage payment up front to ensure that there is enough money to pay for insurance and taxes, and then they actually make the payment. Why? To protect their investment, of course. They don’t want to risk you lapsing on your insurance, or missing a property tax payment.
Escrow is collected for:
- Homeowner’s insurance premium
- Flood insurance (if required)
- Wind insurance
- County, state, and municipal property taxes
Depending on where you live, the amount of the yearly premiums and pre-payments on your taxes can be anywhere from $3,500 a year, to $7,000. Generally speaking, it’s not uncommon for these costs to be about $5,000 a year.
That $5k is split up into 12-month installment payment made along with a mortgage payment during the prior year to pay for the upcoming year. The bank reviews your escrow balance, and what was paid out at the end of the year, to plan and make adjustments for the coming year, if necessary.
This basic example would add about $415 to your monthly mortgage payment. You can learn more about homeowner’s insurance here.
What is the total amount of your mortgage payment?
So to recap, here’s a pretty common example of a mortgage payment we see here in Florida.
Principal Borrowed: $300,000
Interest Rate: 4%
Loan Term: 30 years
Interest and Principal Mortgage Payment: $1,432
Mortgage Insurance Premium: $125
Insurance, Taxes Escrow: $415
Total Monthly Mortgage Payment: $1,972
Getting started with a mortgage
Ready to buy a home? The first step is to consult with a mortgage broker to find out what you qualify to borrow. We always recommend working with a mortgage broker, and you can read why in that post link. Give us a call at 561-500-LIST (5478) and we can connect you with a few potential brokers.