How Mortgage Loan Payments Work

For most every homeowner, a mortgage loan was necessary to avoid buyers having to pay the total home price in one lump sum, something most of us can not afford to do. When you take on a mortgage, you have the financial obligation to make on-time payments based on the price of the loan plus interest, taxes, and insurance.

Structure of a Mortgage Payment

Essential components of a monthly mortgage payment will depend upon the amount of your mortgage loan and the terms within the loan. The term of the loan is the length of time you have to pay back the loan in full. Longer terms, like the traditional 30 year term, will result in smaller monthly payments for the borrower but for a longer period of time. 30 year mortgages will also cost the buyer more overall when interest is factored into the equation. A shorter term loan, like a 15 year mortgage, will make the buyer pay much higher payments each month but will also more money to be applied to the principle of the loan. A 15 year mortgage will allow you to be a homeowner in a faster period of time and save you a lot of money in interest charges.

The mortgage payment is comprised of several elements that make up the total amount due. Here is a breakdown of these components:

Principal Amount Due

The principal amount on a mortgage loan is the amount the borrower received from the lender. Loan repayments are set up so that initially very little of your loan payment goes toward principal and over time the principal amount due will increase. This is due to lenders structuring loans so that the first few years of payments are devoted primarily to interest payments. As time goes on, more of your monthly payment will start being applied to your principal.

Interest Charges Due

The interest on a mortgage loan is essentially the payback to the lender for the borrowed money. The lower the interest rate, the lower a borrower’s monthly payment will be. The calculation of your interest payment will also depend on the type of interest rate you have as a condition of your mortgage loan. An adjustable rate means the interest on your loan changes with the market. Adjustable rates will affect your monthly mortgage payments on a monthly basis. Fixed rates will remain the same throughout the entire course of the loan.

Tax Payments Due

Many of today’s lenders require that real estate taxes be placed in escrow. This means in addition to the principal and interest charges due on your mortgage loan, you will also be paying for your property taxes within your monthly mortgage payment. Property taxes will be collected through regular mortgage payments and held by the lender in an escrow account. When taxes are due, the lender will pay them in full directly from the escrow account. Tax payments change from year to year so if your taxes increase or decrease, it will affect how much you must pay each month with your mortgage.

Insurance Payments Due

Like property taxes, lenders often require buyers to escrow their homeowner’s insurance payments as part of the mortgage terms and conditions. When the insurance payment is due, the lender will make the payment in full from the escrow account. Additionally, a second type of insurance may also be rolled into your mortgage payment. This insurance is called Private Mortgage Insurance, or PMI, and is required by lenders for any homebuyer who can not put down 20% or more of the home price as a down payment. PMI helps reduce the risk on behalf of the lender should the borrower default on the mortgage loan. PMI coverage can be discontinued after a homeowner has created at least 20% equity in the home.

When considering becoming a homeowner, it is important to ensure you have the financial means to cover not only the cost of the principal and interest of a mortgage loan but also the expenses rolled into the loan as required by the lender. Too often homebuyers bite off more than they can chew and miscalculate how much their mortgage note will be. By understanding how a mortgage payment may be structured, you will be able to make a more informed decision about your financial capabilities when it comes to buying a home.