WHAT IS INCLUDED IN A MONTHLY MORTGAGE PAYMENT?
By Jessica Hudson | January 1, 2020
Buying a home can be one of the most rewarding investments you will ever make. However, it can also be one of the costliest. Estimating your monthly mortgage payment well in advance of purchasing can help you make a smart decision with your budget. Understanding what is included (and what is not) in that payment is also a crucial step.
What is a Mortgage Payment?
A mortgage loan is a specific type of long-term loan used to finance the purchase of a home. A mortgage payment is the monthly amount you are required to pay toward your mortgage. The mortgage payment will vary widely depending on the amount of money borrowed (i.e. the “size” of the loan), the length of time within which the loan must be paid back (i.e. the “term” of the loan) and your interest rate.
The size and term of the loan will have the biggest impact on the monthly payment. A higher loan amount or a shorter loan term will require higher monthly payments than a smaller loan amount or a longer loan term. However, your interest rate will also impact your monthly payment. The higher the interest rate, the higher your payments are.
What is PITIA?
The acronym PITIA stands for the five most important components of a monthly mortgage payment beyond the size and term of the loan. Changing any of these five factors will affect your estimated monthly payment.
- Association Dues
The principal is the amount you actually borrowed from the lender. When you first start making mortgage payments, most of your payment will go towards paying the interest. However, the amount of principal you pay off will increase with every passing month, putting you one step closer to owning the home free and clear. In the final years of a loan, you will primarily be paying down principal.
The interest is what the lender charges for loaning you the money. When you first start paying off your mortgage, you will be paying mostly interest. As time goes on, less of your payment will go to interest and more will go toward paying down the principal. If you pay more principal in the beginning by making larger or extra payments, you will reduce the overall amount of interest paid over the life of the loan.
The tax on your property is assessed by government agencies and is used to fund specific municipal services. It is common for lenders to set up an impound escrow account for real estate taxes, where the lender collects a monthly payment designated for your taxes and holds the total until your annual taxes are due. Your annual real estate taxes are divided by 12 and added to the monthly principal and interest amount you are paying. Real estate taxes can vary greatly in different areas. As soon as you identify a property you are interested in, it’s crucial to determine the exact local tax rate prior to closing.
There are two different kinds of insurance coverage to keep in mind during the home buying process: homeowners insurance and private mortgage insurance.
The first type, homeowners insurance, protects the buyer in the event the home is damaged by a natural disaster or any other unforeseen event. Homeowners insurance is typically handled like real estate taxes; the cost is added to the monthly mortgage payment and held in escrow until due. The amount of insurance varies depending on your location, the type of home you are purchasing and the types of coverage you want.
Private mortgage insurance, or PMI, is used on FHA mortgages and on some mortgages when a borrower pays a down payment of less than 20% of the home’s cost. This type of insurance protects the lender in case you are unable to repay the loan amount and default on the mortgage. PMI can vary based on several factors, including loan amount, loan-to-value ratio, property type, and credit score.
Association dues are not part of your mortgage payment you send off to the lender so they are often overlooked in the budgeting process. If you buy a home with a homeowners association, you will have to pay a monthly, quarterly, semi-annual, or annual fee to maintain the amenities in your association. Fees can range from a few dollars a month to several hundred.
Understanding everything that goes into your monthly mortgage payment is a crucial early step in the home buying process. By calculating the principal, interest, taxes, insurance and association dues, you are better able to determine how much your dream home will truly cost.