The 4 costs that make up your monthly mortgage payment
Your mortgage payment can actually be made up of four different costs.
When you borrow money to buy a home, you will need to make a monthly mortgage payment. But it may be surprising that your payment can actually be made up of four separate costs.
It is important to understand each of the individual components of your mortgage payment. This way you will be better informed about the total amount you are spending on housing. And you’ll be better equipped to make decisions that will help lower the cost of homeownership and stay on budget.
Here are the four costs that can make up your monthly mortgage payment.
Principal is the amount you borrow from a mortgage lender when you take out a loan. So if you get a mortgage for $ 280,000, your principal balance is $ 280,000. The payment you make towards the principal is used to reduce your loan balance. For example, let’s say you’ve borrowed $ 200,000 and $ 1,000 of your monthly payment goes to principal. In this case, you will reduce the amount owed on your principal and owe $ 199,000 after you make your payment.
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Typically, when you start paying off your loan, very little of the monthly payment is paid in principal. This is because most of your prepayments are spent on interest, and most of the principal is paid back in the final years of your loan.
Yet, over time, as you pay down the principal, your loan balance will slowly decline. And your loan repayment is structured so that you pay off the entire principal balance over the repayment period (which is usually 15 or 30 years). If you make additional principal payments, you can speed up this process and pay off your mortgage sooner.
Mortgage interest is a percentage of your loan balance. You pay interest as the cost of borrowing from a lender. It’s money the bank keeps, and your interest payments don’t reduce the principal balance you owe.
The higher your mortgage interest rate and the more money you borrow, the more interest you owe each month.
When you own a home, you usually have to pay property taxes to your local municipality. These taxes are collected by your local government. But lenders often don’t believe that you’ll be able to find a large lump sum to pay these taxes and may ask you to put money in escrow each month to cover the cost.
An escrow account is a dedicated account that the lender holds for you where they collect the monthly money you pay and keep it until the property tax bill is due. That way, the lender doesn’t risk you losing your home due to a tax lien, making it difficult to repay it.
Your lender will determine the amount you owe in taxes, divide that amount by 12, and add that amount to your monthly mortgage payment. When you send this money, it goes into your escrow account. Your property tax bill will be sent to your lender and paid from this account.
Home insurance works much the same way as taxes, and you may have to pay it monthly along with your mortgage. Although insurance is paid once a year, lenders will divide the amount owed by 12 and collect payment for it each month. The money is also placed in your escrow account and used by your lender to pay your insurance bill.
Lenders will take these four elements of your payment – principal, interest, taxes, and insurance – into account when determining if you can afford a mortgage. You should also consider them all to see how your loan will fit into your budget and to ensure that you are making a wise financial choice when borrowing. To find out how much you might owe in these categories, use a mortgage calculator to play with the numbers – that way you won’t be caught off guard when making your payments.