Mortgage Payments Explained
Unlike the simplicity of rent payments, mortgage payments are made up of several components. Understanding the structure of a mortgage is important when determining how long it will take to pay off your home loan and what it will cost you over time. Additionally, knowing when and how you make payments will help you stay on top of your mortgage each month. Let’s take a look at what goes into your mortgage payment and your options for paying it off.
What Goes Into Your Mortgage Payments
As a homeowner, you’re likely to encounter unfamiliar terms and jargon relating to mortgages. One of these terms is called PITI, an acronym for the four main components of a mortgage payment: principal, interest, taxes and insurance. Together, they make up what you pay on your mortgage every month. This helps both you and lender determine what you can afford when shopping for a home.
Principal and Interest
The basic mortgage payment consists of two components:
- Principal: The amount you initially borrow from a lender to buy your home. It’s factored into your monthly payment and paid off throughout the life of your loan.
- Interest: The percentage of the principal you pay over the life of the loan to your mortgage company as a fee for lending the money.
Once you purchase a home and begin making payments, the amount of principal you pay each month is relatively low. As the loan ages, more and more of your monthly payment will go toward the remaining principal amount.At the same time, the amount that goes to interest will continue to decrease as your pay down your loan. This is referred to as mortgage amortization.
Amortization is a scale that tells you how much of your mortgage payment is being applied to your principal and interest from month to month. While the makeup of your mortgage payment changes through the life of your loan, your total monthly payment will remain the same. Keep in mind that amortization does not factor in other parts of your mortgage payment like taxes and insurance. Using an Amortization Calculator will show you just how much you pay each month on principal through the life of your loan.
No matter where you live, you’ll pay property tax on your home. The amount you pay in property taxes is based on a percentage of your property value, which can change from year to year. The actual amount you pay depends on several factors including the assessed value of your home and local tax rates. Typically, every county has its own taxation system.
If the value of your property increases, the taxes you pay on your property will increase with it. However, this also means you’re gaining equity faster which you can convert into cash if you need to. When shopping for a home, be mindful of local property tax rates. It makes a difference in your overall housing cost as tax rates vary across the country.
When it comes to your home itself, any changes or improvements made to it will affect the amount you pay on taxes. In the other words, the tax rises and falls with the value of your home. Keep in mind that the assessed value of your home may not be the same as its market value. For taxing purposes, the assessed value is taken into account. The frequency in which property value is assessed varies by location, just like tax rates.
In the event of an environmental disaster or an accident on your property, homeowners insurance works as a safety net to protect your home and finances. If something were to happen, your homeowners insurance would typically cover the cost of repairs to bring your property value back to where it was before.
While the most basic protection covers damage to the home itself, homeowners insurance can also cover damages to other structures around your home, stolen or damaged personal property, and liability in the event someone injures themselves on your property.
It’s important to note that homeowners insurance also protects your mortgage investor (such as Fannie Mae, Freddie Mac, FHA, etc.), which is why they require it in order to approve your mortgage. The insurance not only protects your home, but their investment in your home as well.
What Determines the Cost of Homeowners Insurance
Typically, homeowners insurance premiums vary by state. For example, if you live in a flood zone or a state regularly impacted by hurricanes, you may be required to buy additional coverage that protects your home in the event of a flood. If you live near a forest area, additional hazard insurance may be required to protect against wildfires.
Along with your home’s location, the home itself determines how much you pay for insurance. For example, brick homes typically have lower insurance premiums than homes primarily made from flammable materials such as wood. Other factors include your home’s overall condition and age. Even the contents inside your home can determine what you pay.
As with any insurance, you can save money by increasing your deductible, which will lower the amount you pay toward your premium. How much you save and whether doing this makes sense depends on your coverage and the state you live in.
If you can’t make a sizable down payment on your home, you’ll likely have to pay mortgage insurance. This type of insurance covers the lender if the loan goes into default. When you put a low-down payment on a home, the lender is taking on an additional risk in giving you a home loan. Mortgage insurance reduces that risk. How much you pay depends on several factors including your loan type, loan amount and credit score. There are a couple of different types of mortgage insurance depending on your loan.
Conventional mortgages use private mortgage insurance (PMI). As part of the loan guidelines set out by Freddie Mac, Fannie Mae and most investors in conventional loans, a borrower is required to pay PMI when at least 20% of a home’s purchase price is not provided as a down payment. Most home buyers can’t afford a 20% down payment, so paying mortgage insurance is not uncommon.
When obtaining a mortgage, it’s important that you find a loan that fits your specific situation and goals. Quicken Loans offers the PMI Advantage program, in which borrowers can choose a slightly higher interest rate to take advantage of lender-paid PMI.
While conventional loans have more strict underwriting guidelines, FHA loans require a small amount of cash to close a loan. As a result, all borrowers must pay a mortgage insurance premium (MIP) to insure the investor is protected against loss if the homeowner defaults on the mortgage. While there are ways to avoid PMI with conventional loans, there is no way to avoid MIP on FHA loans because the minimum down payment is only 3.5%.
Whether MIP can ever come off your FHA loan depends on a few factors, including when it was originated, the amount of your down payment and the current LTV.
Escrow: How Taxes and Insurance Are Paid
Depending on your mortgage program, part of your payment will go into an escrow account. The amount of money that's added for escrow depends on your property taxes and insurance premiums. Your lender will analyze your account each year to make sure they're collecting the appropriate amount of money. If necessary, they’ll adjust the amount that you’re required to pay for taxes and insurance.
Making Your Mortgage Payments
There’s more than one way to pay a mortgage. From the frequency of your payments to how they are paid to the lender, there are several ways you can approach it. Knowing your options can help you decide the best course of action when it comes time to making payments on your home.
While monthly mortgage payments are most common, your lender may give you the option to make bi-weekly payments. With a bi-weekly payment schedule, your payment becomes more manageable because it’s cut in half. Also, there are 52 weeks in a year. This comes out to 26 half payments or 13 full monthly payments per year. The extra payment gets applied directly to your principal. As a result, you pay less interest throughout the life of your loan. Quicken Loans offers monthly and bi-weekly payments without charging additional fees.
How to Make Mortgage Payments
Just as you might go online to make a car insurance or phone bill payment, you can pay your mortgage in the same way. You can still make payments by mail or phone, but the ease and convenience of paying online makes it a more favorable option among homeowners. One reason for this is the ability to set up automatic payments.
Although many homeowners can set up recurring payments that are taken directly out of their bank account through the bank’s online payment system, there are advantages to setting up automatic payments directly with your lender.
Mortgage payments sometimes change. The amount necessary for taxes and insurance may go up or down every year. The same is true if you’re in an adjustable rate mortgage (ARM) at the end of its fixed period. By setting up an automatic payment through a lender as opposed to the bank, you can make sure the payment isn’t too low and that you’re not overpaying when your escrow or rate goes down.
What Happens If You Miss a Payment
Typically, you won’t have to pay a penalty if you’re only a few days late on your mortgage payment. Most lenders provide a grace period for borrowers to make a late payment without having to pay an additional late fee. Most grace periods are around 15 calendar days, but you should verify this with your lender to be certain of their late payment policy.
It’s important that you contact your lender if you’re going to miss a mortgage payment. Waiting to resolve the issue can lead to defaulting on your loan. Consequences could include late payment fees, penalties and a drop in your credit score.
Falling behind on your payments can also lead to legal action and foreclosure. Your lender can offer you several options designed to help you get back on track with your mortgage payments.
We’re Here for You
Paying a mortgage is a huge commitment. There’s no such thing as being too prepared. Knowing what goes into a mortgage and how you can manage payments will better prepare you for the future. If you’re ready to buy a home and want the convenience of a fully online mortgage experience, we’re here to help! Discover your options by applying online with Rocket Mortgage® by Quicken Loans®. You can also reach out to one of our Home Loan Experts at (800) 785-4788.