Mortgage Payment

Understanding Your Mortgage Payment on Home Purchase

Gustan Cho Associates are mortgage brokers licensed in 48 states

Understanding what your mortgage payment consists of is very important for homeowners. Most people do not pay in cash for their first home and get a mortgage loan. So it’s important to understand mortgage payment before buying a home. This article tells you what goes into a mortgage payment, how your mortgage payment reduces your loan balance, and how you pay off your home loan.

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What Is a Mortgage Payment?

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When you borrow to buy a home, your lender advances you a sum of money to pay the seller. You then repay your lender in monthly installments. Your lender calculates a payment amount that will pay off your loan completely at the end of your loan term.

Each monthly payment is divided into two parts — the interest on your loan for the previous month and a reduction of your loan balance.

The loan balance is also called the loan “principal” and your mortgage payment consists of principal and interest, aka P and I. A homebuyer or homeowner obtaining a mortgage loan  will have a mortgage payment due once a month. The mortgage payment consists of the principal and interest. The housing payment required by the lender may include principal, interest, taxes, and insurance or PITI.

What Makes Up The Mortgage Payment

Principal payment is paying down the original loan amount. Over time, as you make your monthly mortgage payments, the principal balance of your loan decreases and eventually the loan balance will get paid off. Interest payment is the cost of borrowing money for your mortgage loan. It is an interest expense and it does not go towards paying down your principal loan balance.  The interest portion of your mortgage payment is the cost of borrowing money and is the portion of the payment of the interest expense. The interest rate is typically expressed as APR.

You interest rate of your mortgage loan is based on various factors, including your credit score , loan level pricing adjustments, risk factors, loan-to-value, debt-to-income ratio, type of property, and the prevailing market rates.

Your mortgage payment may include other costs and agreements. These additional costs are often collected by the lender and held in an escrow account, from which they are paid when due. Mortgage payments are usually made every month, but they can also be made biweekly or annually, depending on the terms of your loan. The loan amount, interest rate, loan term (e.g., 15 years, 30 years), and any additional costs included in your mortgage agreement. You can use a mortgage calculator to estimate your monthly mortgage payment based on these factors.

What Is Amortization?

Amortization is the process of paying off your loan balance. The terms “amortization” and “mortgage” come from an old English word meaning “to kill” and your goal for your mortgage is to kill it off and owe nothing on your house! Here’s how it works: Suppose that you have a $300,000 mortgage at a 4% interest rate. Your monthly payment is $1,432.25. At the end of Month 1, the interest charged by the lender equals $1,000, and the rest of your payment — $432.25 — is subtracted from your principal balance. In Month 2, then, your principal balance is $299,567.75. Because your balance is a tiny bit lower, your monthly interest is also lower. It’s $998.56 this time. That means more money goes toward reducing your principal balance — $433.69. Over time, less of each payment goes for interest, and more goes toward reducing your principal balance. This is important to know, especially if you want to pay off your loan sooner and reduce your interest cost over the life of your loan.

How Do Lenders Determine Your Mortgage Payment?

How Do Lenders Determine Your Mortgage Payment?Your mortgage payment depends on three things:

  • Loan amount
  • Loan term (years)
  • Interest rate

You can see how these factors interact with an online mortgage calculator. Your payment increases if the loan amount or interest rate goes up. Your payment decreases when you choose a longer-term like 30 years and decreases when you choose a shorter repayment term like 15 years. It’s important to understand this because it affects the affordability of your home loan. For instance, you might be able to afford a maximum of $1,000 P and I payment per month. You could borrow about $209,000 at 4% over 30 years. But if you find a 3.5% loan, you could borrow almost $223,000. If you choose a 15-year term at 4%, your maximum loan amount drops to about $135,000. But 15-year loan interest rates are lower — if you borrow at a 2% interest rate, you can finance just over $155,000.

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Other Parts of a Mortgage Payment

The P and I are probably just part of your mortgage payment because most lenders require borrowers to also pay their homeowner’s insurance and property taxes with their monthly P and I. That’s because they want to make sure that you pay these costs on time. When the lender adds these amounts to your payment, they call it an “escrow” or “impound.” Lenders divide the annual amount of your taxes and insurance, divide it by 12 months, and add that amount to your P and I payment. The entire amount is called PITI for principal, interest, taxes, and insurance.

But Wait, There’s More

Your mortgage payment might include even more than PITI. Borrowers who put less than 20% down on their homes usually also pay for mortgage insurance. Mortgage insurance policies pay the lender if you default (don’t pay your mortgage). And if you buy a home in a designated flood zone, you’ll also have to purchase flood insurance.

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