Couple and a realtor

Understanding Your Mortgage Payment

You borrow money to buy a home and think you pay back just the amount borrowed plus interest, right? Wrong.

Mortgage payments have many pieces that if you don’t understand them could make it difficult to budget. Here’s what to expect in your mortgage payment.

Principal

Your principal payment is the part of the amount you borrowed that you pay back each month. The principal balance decreases as you make your payments. Early in the mortgage term, though, you’ll pay more interest and less principal. As you get closer to the middle and end of the term, though, you’ll pay more principal than interest.

Interest

Lenders charge interest to lend you the money. It’s how they make a profit and can continue making loans. Each loan has different interest charges or even types of interest rates.

Before you take out a loan, consider whether you want a fixed-rate or adjustable-rate loan.

Fixed rate loan

A fixed-rate mortgage has the same interest rate for the life of the loan. You lock in the interest rate before you close and that’s your rate for the loan’s term.

Adjustable-rate loan

An ARM rate changes annually after the initial fixed period which may be 1 – 10 years depending on the loan. Adjustable rates are based on an index and predetermined margin, which your lender sets before you close.

Term

The term is how long you have to repay the mortgage. Many first-time homebuyers choose the 30-year term because it has the lowest payment. The tradeoff, however, is a higher interest rate as 30-year terms are riskier for lenders than shorter terms.

Other term options including 10, 15, 20, and 25-year terms. The shorter the term the lower the interest rate lenders usually charge and the faster you’ll own your home. But, shorter terms come with higher payments because you have less time to pay off the principal.

Mortgage Insurance

If you take out a conventional loan, FHA, or USDA loan, you may pay mortgage insurance. Conventional loan borrowers pay mortgage insurance when they put down less than 20% on a home. But they only pay PMI until they owe less than 80% of the home’s value.

FHA and USDA borrowers pay mortgage insurance for the life of the loan or until they refinance into a conventional loan. Mortgage insurance varies depending on the loan type and your qualifying factors.

Escrow Payments

Many borrowers include their real estate taxes and home insurance in their mortgage payments. Whether the lender requires it or you do it for convenience, it’s easy to ensure your taxes and insurance remain current. To escrow your taxes and insurance, your lender will include 1/12th of both the taxes and insurance in your monthly payment.

Bottom Line

Understanding the full cost of a mortgage payment is important. It’s more than your principal and interest. A mortgage payment includes mortgage insurance and your escrow payments. It may even change if you have an adjustable-rate mortgage. Understanding how your mortgage payment works before taking out a new mortgage can help you budget accordingly.
Read next: steps to get approved