If you’re buying your first home, you might feel overwhelmed by what a mortgage payment includes. There are many moving parts, and it’s more complicated than a rent payment, but once broken down, it’s easy to understand.
Knowing what goes into how much you pay each month on your mortgage can help you prepare for homeownership by understanding how much you can afford and what each part of your payment covers.
What is a Mortgage Payment?
A mortgage payment is a monthly payment made to your mortgage lender to pay back what you borrowed. You’ll pay the amount you borrowed back over a term, usually 15 to 30 years, plus the interest lenders charge.
The ability to break your payments down over the long term is how most people can afford to buy a home worth hundreds of thousands of dollars. You’ll owe a mortgage payment every month. Plus, if you miss too many payments, you could lose your home in foreclosure.
What Makes up your Mortgage Payment?
Your mortgage payment is made up of more than just the principal and interest. Here are the components of mortgage payments.
The principal is the amount you borrowed to buy the home. For example, if a home is $200,000 and you invest $20,000 of your money, your principal balance is $180,000. Your principal balance decreases as you make your monthly payments, which also increases your home equity.
You’ll pay less principal at the start of the loan, but as you get further into the term, you’ll pay more principal and less interest.
Interest is the lender’s charge for borrowing the money. It’s how lenders stay in business, lending hundreds of thousands of dollars at a time. Then, when you start making payments, they are mostly interested because you owe a large amount of principal.
As you pay the principal down, your interest charges decrease, and you pay more toward the principal.
The interest is a percentage of your loan amount. For example, you can get a fixed-rate loan with the same interest rate for the life of the loan or an adjustable rate that adjusts annually, changing your mortgage payment each year.
Real Estate Taxes
Most lenders require borrowers to set up an escrow account for their real estate taxes and homeowner’s insurance. This means 1/12th of your real estate tax bill will be included in your mortgage payment.
Lenders keep the funds in a separate escrow account and pay your real estate taxes before your due date. As a result, your mortgage payment may change periodically if your real estate taxes increase after being reassessed.
Lenders require borrowers to carry homeowner’s insurance to protect themselves and the borrower. In addition, homeowner’s insurance provides financial protection should there be a total loss. Without it, lenders would lose a lot of money each time a home had a total loss.
Like real estate taxes, your homeowner’s insurance payment is 1/12th of the insurance premium and could change annually if your premiums increase.
If your neighborhood or community development has a Homeowner’s Association, lenders will usually include the dues in your monthly payment. The HOA dues cover things like garbage collection, snow removal, and maintaining common areas, including shared roofs, walls, and gutters.
If you borrow a conventional loan with a loan-to-value ratio higher than 80% or an FHA or USDA loan, you’ll pay mortgage insurance in your monthly payment. Like homeowner’s insurance, your mortgage insurance is 1/12th of your annual premium, but you pay it monthly.
If you borrowed a conventional loan, you can cancel your Private Mortgage Insurance after you owe less than 80% of the home’s value.
How do Mortgage Payments Work?
Now that you know what your mortgage payment is made of, here’s how to make mortgage payments.
When is your First Payment Due?
When you buy a home, your first mortgage payment is due after the first full month after your closing. This is because interest is paid in arrears, so the interest you pay in November covers October’s interest.
How your Mortgage Payment is Applied
Your mortgage payment is made up of principal and interest plus any amount that goes to the escrow balance.
The amortization table you receive at the closing will show you how much of each payment covers interest and principal each month.
Most loans allow you to make extra principal payments, which reduces your interest charges and pays your principal off faster. When you make extra payments, make note that they are to go toward the principal, so the funds are properly applied.
Tax Benefits from Mortgage Payments
Your mortgage payments may also provide more tax benefits if you itemize your deductions. Keep careful track of the interest and real estate taxes you pay each year because you may be eligible to write them off on your taxes.
How to Calculate your Mortgage Payment
Using a mortgage calculator is the easiest way to calculate your mortgage payment. To calculate it, you’ll need the following:
Amount of the down payment
Estimated interest rate
The term you’re borrowing the funds (10, 20, 30 years)
Total sales price
Estimated property taxes
Estimated homeowner’s insurance
Estimated mortgage insurance
The calculator will determine the amount of principal and interest you’ll pay each month and include any extra costs, such as real estate taxes and homeowner’s insurance.
Your mortgage payment is more complicated than rent, but you get many more benefits. For example, owning a house means you earn equity in the home that you can use for future financial needs. You may also be eligible for certain tax deductions based on the interest and taxes you pay.
Knowing how a mortgage payment is calculated and what you’ll pay can help determine how much you can afford when you’re ready to buy a home.