The Components of a Mortgage Payment

Ever since the 1930s, when the modern mortgage came into existence, most home buyers have relied on long term financing to pay for their purchase. The mortgage is paid over the course of many years, typically 15-30, and therefore the payments are broken down by month. However, in a conventional mortgage, each monthly payment does not go directly toward the mortgage principal. Interest, insurance and taxes are also usually included in the overall cost of the loan, so a portion of each payment must go toward each of these components.

The four main components of a mortgage payment are Principal, Interest, Taxes and Insurance, commonly abbreviated as PITI.

Principal

A portion of each mortgage payment is applied to the mortgage principal balance. The principal amount of the mortgage gets paid off slowly at first, with more of each payment going toward interest. Loans are normally structured so that the portion of the payment that is applied to the principal starts out low and increases slightly with each payment. This is why it is usually more difficult to refinance a home or sell a home for a profit within the first few years, as the home has not built up enough equity. Equity is the accrued value of the home, calculated by subtracting the amount of money owed by the current market value. For instance, if your home is currently worth $200,000 and you owe $190,000, your equity would be $10,000.

Interest

Interest is the fee lenders charge for their service of letting you borrow money. The higher the risk, the higher the interest. If you’re a borrower with excellent credit and a sizeable down payment, you’ll likely qualify for a low interest rate. If your credit is less-than-ideal and you are unable to make at least 20% down, you may be charged a higher rate as well as private mortgage insurance (PMI). It is in each mortgage borrower’s best interest to be as creditworthy as possible, in order to avoid paying costly interest and insurance fees.

For mortgage payments, the portion that is applied to the interest is usually much higher than any other portion. Just as the potion that gets applied to principal starts out low and gradually increases, the opposite holds true for the portion applied to interest; it starts out larger and gradually lowers over time.

Taxes

Real estate taxes are often included in the homeowner’s mortgage payments for convenience. The lender holds this portion of the mortgage payment in escrow until the taxes have to be paid.

The government determines the amount of each homeowner’s real estate tax. Homeowners have the option of paying the taxes themselves, but most find it a lot easier to include the payments in their mortgage payment each month. The amount of real estate tax that is due is divided by the total number of monthly mortgage payments in a given year.

Insurance

Just like with real estate taxes, insurance may be paid separately by the homeowner or may be included in the monthly mortgage payment. There are two types of insurance that can be included in the mortgage payments: the property insurance, aka homeowners insurance, and private mortgage insurance (PMI).

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