What is included in a total monthly mortgage payment?
When you rent a home or apartment, you probably don’t think twice about where your monthly payment goes. You give your landlord a check, they cash it, and everyone sleeps soundly.
But since you’re about to experience homeownership, you need to change the way you think about your housing costs. That’s because when you have a real estate mortgage, your monthly payment doesn’t just go to a lender; it goes to several different parties. If you want to stay on top of your finances and keep costs down, you need to understand where each penny flows.
Pour a cup of coffee, sit back, and let’s demystify what a total monthly mortgage payment includes.
What is a down payment?
When you buy a house, you typically have to make a down payment — or initial lump sum offering — towards the purchase price of your property.
For example, suppose a property costs $350,000, and the lender requires a 20% down payment to avoid private mortgage insurance. In this scenario, you would need to come up with $70,000 upfront to secure financing.
There are other expenses in the homebuying process, like closing costs, agent commissions, inspections, appraisals, and insurance. These additional costs can vary based on the location and property type, so it’s advisable to consult with a real estate professional or lender to get a more accurate estimate of how much you might be on the hook for.
While the initial payment may seem significant, remember that the buying process is a financial test. Homes can be expensive to maintain and unexpected costs may — and, let’s face it, almost certainly will — arise over time.
Just wait until your kids break windows, appliances stop working, or your basement floods. The more you can save now, the better off you’ll be when an emergency happens.
What is a mortgage?
Unless you’re paying off the entire home price in cash, you’ll cover the remaining property cost by securing a mortgage or home loan. To continue our example, after putting down 20% on a property worth $350,000, you would need a $280,000 mortgage to cover the rest of the home’s value.
Homeowners often pay mortgages in monthly installments lasting anywhere from 15 to 30 years or longer. This allows you to spread the loan balance over a long period of time.
Monthly mortgage payment: A breakdown
A monthly mortgage payment contains several different components. Every month, you can expect your total monthly payment to flow to each of the following items.
Principal
The principal amount balance refers to the money that applies to reducing the original loan balance. If you borrow $280,000, that’s the number you’ll be whittling away each month after taxes and interest are accounted for. Generally speaking, fixed-year mortgages are frontloaded with interest, so your monthly checks only take small bites out of the principal at first.
Interest
Interest is the cost of borrowing money from the lender. Mortgage providers calculate interest as a percentage of the remaining loan principal. Interest typically accounts for the bulk majority of mortgage payments. The total amount of interest you’ll pay primarily depends on the rates set by the Federal Reserve at the time you apply for a mortgage. They are also influenced by whether you have a fixed-rate mortgage or an adjustable home mortgage.
- In a fixed interest rate mortgage, interest is constant throughout the life of the loan. In other words, it doesn’t fluctuate with changes in market interest rates or economic conditions. If you bought a house at 3.5% interest using a fixed 30-year loan, your interest rate won’t change over those three decades (unless you choose to refinance to get a lower interest rate).
- An adjustable-rate mortgage (ARM) changes over time depending on market conditions. Commonly, homebuyers start with an initial fixed interest rate for a few years, and then the mortgage rates reset depending on what the market is currently charging. ARMs can be risky because you never know when you’ll end up with a higher rate after the loan recalibrates. However, if you’re only planning to stay somewhere for a few years, this could be a more affordable short-term option.
Private mortgage insurance
Private mortgage insurance (PMI) is a type of insurance that protects lenders when the borrower defaults on their mortgage loan and forecloses.
Lenders typically require homebuyers to purchase PMI when they put less than 20% down on a property. While it’s always advisable to put down at least 20%, you can afford a property by putting down as little as 3.5% by securing a loan from the Federal Housing Authority, also known as an FHA loan.
PMI is usually temporary and automatically cancels once the borrower’s loan-to-value (LTV) ratio reaches 78%. Borrowers can also request a cancellation or wait until the midpoint of the loan term for automatic termination under the Homeowners Protection Act (HPA).
Do mortgage payments cover homeowners association fees?
Mortgage payments do not cover homeowners association fees, or HOA fees, because HOAs are separate entities from lenders, and funds given to them are put toward improving the community. If you end up living in a property governed by an HOA, you need to pay them separately to cover services and amenities (e.g., pools, fitness centers, and common areas).
Do mortgage fees include property taxes and insurance payments?
Mortgage payments do not always include homeowners insurance premiums and property taxes. However, it’s common for mortgage lenders to include them as part of the monthly payment. The corresponding acronym for payments that cover all of these is principal, interest, taxes, and insurance (PITI).
Sometimes, a lender might make a homeowner pay for the first year of insurance at closing. After that, the homeowner is responsible for paying the insurance company directly. Generally speaking, the decision to include insurance and tax bills in mortgage payments depends on the type of home loan (escrow or non-escrow) and the borrower’s financial situation.
Escrow account
Lenders often require borrowers to have an escrow account. These accounts hold a portion of the monthly mortgage payment, which the lender manages and uses to pay property taxes and, in some cases, the homeowner’s insurance policy.
An escrow account helps the homeowner stay current on their monthly obligations and simplifies budgeting for the borrower. The downside is that the homeowner usually has to maintain an escrow balance.
Non-escrow account
A non-escrow — or non-impound — account is one where the lender allows borrowers to manage their own taxes and insurance independently. In other words, the borrower becomes responsible for paying property taxes and insurance to their local government and insurance company.
Sometimes borrowers can ask their lenders to switch to a non-escrow account and take full responsibility for their taxes and insurance. For this type of request, the lender may ask for documentation to assess eligibility and financial responsibility. In the event your escrow account has a shortage due to increased taxes or insurance costs, you may first need to pay off the deficiency before the lender agrees to make the switch.
What is amortization?
Amortization is the process of paying off a loan over a specific term through regular installments. The two most common examples of amortization include home and auto loans.
With an amortizing loan, each payment amount covers a portion of the loan’s principal and a portion of the mortgage interest payments for the remaining balance. Any time you have an amortizing loan, the goal is to fully pay it off by the end of its term. Better yet, if you want to reduce your interest expenses, you might even want to pay it off sooner than that.
Best practices for monthly mortgage payments
Having a mortgage is nothing to lose sleep over. In fact, you could potentially wind up with a mortgage that is comparable to or even lower than what you’re currently paying in rent — especially if you put in a sizable down payment and choose a property in a favorable housing market.
What’s more, you’ll essentially pay yourself a portion of each monthly installment by building equity — or ownership — instead of forking over payments to a landlord. As time passes, your principal will drop, and your ownership equity will increase. In other words, you’ll own more of your house!
As you begin getting ready to make mortgage payments for the foreseeable future, keep these tips in mind to streamline the process and avoid complications.
Always pay on time
Always make your payments on time, before the due date. Late payments can result in late fees and penalties. They can also negatively impact your credit score.
Create a budget
Currently, 61% of Americans live paycheck to paycheck, even with inflation cooling. If you fall into this camp, be extra careful if you’re aiming to carry an expensive mortgage.
By creating a budget and sticking to it, you can ensure there’s enough money left over at the end of the month to make your mortgage payment. You may be unable to eat, put gas in your car, or buy basic household items — but at least you’ll have a roof over your head!
Make extra principal payments
Consider making extra payments toward your principal balance every month. This can help pay down your mortgage faster and reduce your interest costs over the life of the loan. If you take this approach, be sure to check with your lender about potential prepayment penalties.
Review your mortgage statements
Each month, review your mortgage statements to ensure they are correct and there are no errors or discrepancies. This is especially important any time you switch lenders during a loan.
Be careful about refinancing
At some point, you may consider refinancing your mortgage to lower your monthly payments. This might be a good idea for someone who buys a home when interest rates are high and then decides to refinance when they fall back down to earth. However, excessive refinancing could result in higher costs over time when factoring in loan term extensions and closing costs.
Try these mortgage calculators
Before you start aggressively looking for homes, it helps to understand what you can afford. Start by using a free mortgage calculator to estimate your potential payments.
Here’s how they work: A mortgage calculator asks you to input specific details about your home purchase and then generates an approximate monthly payment. For example, it may ask for items like your loan amount, interest rate, loan term, down payment, property taxes, and insurance costs.
Looking to get a better idea as to how much you can afford? Try free mortgage calculators from sites like Bankrate, Zillow, and Calculator.net.
Thinking about a mortgage? Explore our pre-approval checklist
Now that you know what makes up a mortgage bill, you can move on to the next step of the homebuying process: preparing for mortgage pre-approval.
This is an initial step for first-time homebuyers where a lender reviews your financial information to determine how big of a mortgage you can afford.
To learn more about how you can get a head start on buying your new home, check out our ultimate mortgage pre-approval checklist.
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