Do you know how much your monthly mortgage payment is? If you are like most homeowners, you probably mail out a check blindly every month without even knowing where your money is going. In fact, a large percentage of homeowners don’t know their exact interest rate or what they currently owe on their loan balance. They spend weeks before the closing trying to get the best possible loan terms, only to quickly forget about everything once they get in the house. Whether you are an investor or a homeowner, you should have a good idea of what your mortgage payment is. These figures impact the rest of your monthly budget or monthly cash flow. If you never knew, or need a refresher course, here are the components of your mortgage payment:
1. Principal: The principal is the repayment of your loan amount. This is the portion of the payment that is used to reduce the balance you owe. It may be obvious, but the larger the balance, the higher the mortgage payment. If you take a fixed interest rate option, your principal repayment will be the same for the life of your loan. There is a lot of information on your repayment from your amortization schedule. This is a breakdown of every payment for whatever term you select. A greater amount of principal is paid during the back half of your loan. The first seven years of a thirty year loan will go mostly towards the interest. Your lender wants to earn their interest back first before they start reducing principal. This is a method banks use to protect themselves in the event of a default. The next time you get a minute, go on your lenders website and print off a copy of your amortization schedule. You may be surprised at just where your monthly payment goes.
2. Interest: Interest is basically the profit that goes to the lender. As mentioned, lenders will always get their interest in the first few years of the loan repayment. Most buyers are obsessed with what interest rate they are qualified for on their loan. The larger the loan amount, the greater the change in rate impacts the monthly payment. The difference between 4 percent and 4.25 percent on a $100,000 loan will only equal a change of less than $20 a month. On a $400,000 loan, the same change will go all the way to almost $60 a month. The most important part of interest is that it is compounded. The total interest is significant, regardless of your interest rate. The principal and interest portions are typically lumped together on your monthly statement. Assuming you took a fixed rate, this number will never change during the life of your loan.
3. Taxes: Taxes are the most important part of your mortgage payment. This is often the area that is most overlooked, but it is the most important. Almost all lenders require you to include, or escrow, the taxes into your monthly payment. The reason they do this is because property taxes take lien priority over everything else. If your taxes weren’t escrowed and you defaulted on your tax payment, the town could begin the foreclosure process. The tax portion of your payment could change from year to year depending on the town. If you escrow, you place the next tax payment or two with your lender and they pay the taxes for you. The odds are you will never see a tax bill again. If you have extra in your escrow account at the end of the year, your lender may cut you a check. In most cases, they simply roll it over to next year. If your mortgage payment has increased and you don’t know why, take a look at the tax portion.
4. Insurance: Like your property taxes, the insurance is typically escrowed into your monthly payment. Lenders do this to ensure that you are always covered in the event of an emergency. From time to time, your insurance company may check out the condition of the roof or rates may increase. The taxes and insurance typically do not experience much fluctuation, but if there is a run on foreclosures or if the town was impacted by weather issues, it could change significantly in a matter of months.
5. Private Mortgage Insurance (PMI): If you are like most homebuyers, you bought your house putting less than 20 percent down. Under this scenario, you make a payment that is included in your monthly mortgage towards monthly PMI. This money is considered protection against mortgage default by your lender. For conventional loans, you continue making this payment until you have 20 percent equity in your property. There have been recent changes to FHA programs that keep this PMI payment for the life of the loan. With interest rates at historically low levels, it is important to know the duration of PMI payment before you commit to a loan. With rates sure to rise, the change may be too high to make it worth eliminating the PMI portion of your mortgage.
Knowing what these components are and where they go allows you to look for areas to save money. The more you know about your monthly mortgage payment, the betterdecisions you will make.