When you buy a house, most people expect to pay back the amount borrowed plus interest. But, did you know that a mortgage payment is made up of more than just principal and interest?
In some cases, a mortgage payment may have five or six different parts to them. For the first-time homebuyer this can seem daunting and overwhelming, but when you learn about the components of a mortgage payment, you will better understand what you’re being charged and how to plan for it.
Generally, a mortgage payment is made up of Principal, Interest, Taxes and Insurance. Depending on your down payment and home location, you may also have Mortgage Insurance and Homeowners Association Dues.
PRINCIPAL
The principal portion of your mortgage payment will go directly toward your loan’s principal balance every month. The more mortgage payments you make over time, the more the principal balance decreases.
In the early stages of your loan, you will pay less principal toward the loan and more interest. As time progresses, you will pay more principal and less interest.
INTEREST
The interest on your loan is the cost of borrowing the money to purchase your home. The amount of interest you pay each month will be determined by your interest rate and loan balance.
A higher credit score will yield a borrower a better interest rate than those that are given to low to middle score borrowers. This annual interest rate is divided by 12 to get a monthly interest rate which is applied to your principal balance each month.
For example, let’s assume for your first loan payment your principal loan balance is $300,000 and your interest rate is 5.5%. Your monthly interest rate will be .458%. This amount will be charged to your principal loan balance every month. In this case, the interest portion of your payment would be $1,374 and the principal portion would be $328. Your loan balance for your second payment will be $299,672. As the loan progresses, the interest will continue to decrease while you pay more to the principal balance each month.
INSURANCE
Insurance will offer the borrower and lender protection from financial risk. Not all insurance, however, will protect the borrower.
Property insurance is the most common type of insurance associated with a mortgage payment. This type of insurance protects the homeowner from property damage due to natural disasters, fire or theft.
In some cases, a homeowner might be required to carry flood insurance on the property depending on the FEMA flood certification. This will be an additional cost to the normal property insurance. You can check to see if a home is located in a flood zone by visiting FEMA’s website.
The other type of insurance you could see in your monthly payment is mortgage insurance. This protects lenders in the event the borrower defaults on the loan. It lowers the risk for lenders to lend money and allows them to sell your mortgage to investors. Unless you put at least 20% down on your home, you will more than likely have to pay mortgage insurance to your lender. You can have the mortgage insurance removed once you have gained at least 20% equity in your home.
All annual insurance premiums will be divided by 12 and added to your mortgage payment each month. No matter the insurance you have, all funds will be held in an escrow account by your lender and then dispersed to the appropriate party on the due date each year.
TAXES
Every property will have a tax assessment applied to the estate every year called the annual tax rate. Much like insurance, this tax rate is divided by 12 and then added to your mortgage payment every month and held in an escrow account.
Buyers should look at property’s annual tax assessment before purchasing a home as it will vary depending on the home’s location. In most cases, houses closer to suburban and metropolitan areas are subject to a higher tax rate than those in rural locations.
HOMEOWNERS’ ASSOCIATION DUES
Homeowners’ association (HOA) dues are not typically collected with your mortgage payment, but they should still be considered by anyone looking to buy a home.
These dues (or fees) will be collected either monthly, quarterly or yearly by the HOA that governs your community. These dues will go towards the maintenance of common areas, trash removal and allow the association to set rules for the community to abide by.
Not every home will have an HOA, but they are becoming more common as people move to more populated areas.
While they are not collected with the payment, HOA dues should not be neglected as the association can place a lien on your home for any unpaid dues and force the sale of your property to recover the unpaid funds.