Mortgage payments are designed to chip away at the money you borrowed to purchase your new home. These not only pay down on the amount borrowed, but they also take care of interest and other bills due on your home. A first-time home buyer may be surprised to learn that mortgage payments can fluctuate year to year. Your payment amount the first month will likely not be the same five years down the road.
So, how is a mortgage payment broken up and why does the amount change? The P.I.T.I. acronym helps explain the four parts of a mortgage payment: principal, interest, tax, and insurance.
The principal is the value of the loan you received from your bank or lender. This is the original portion of money you borrowed – i.e. if your home purchase is $300,000 and you paid 20% down ($60,000), your starting principal is $240,000. You can make additional “principal only” payments towards your mortgage as long as it is allowed by your financial institution. Putting any extra funds towards your principal can really add up over time and take years off your loan.
Interest is the amount a lender charges for making the loan. It is a percentage of your loan, or principal. Generally, the higher the interest rate, the higher the mortgage payment. Mortgage interest is amortized, which means your payments are the same month to month, but the percent you are paying towards principal and interest will change. At first, payments will be more interest than principal, but that will change over time. Eventually you will start paying off interest and paying more towards principal.
To see how amortization works, check out our mortgage calculator. Enter the amount you would borrow for a home, the term of the loan (typically 15 or 30 years) and an interest rate. Check the box to report amortization monthly and click on View Report. Scroll down and you’ll see exactly how much of your monthly payment goes to interest and how much goes to principal each month. It’s important to note taxes and insurance are specific to the home you end up buying, so they are not included in this calculator, but would be added onto your monthly mortgage payment.
Your mortgage payments can also include property taxes, which pay for municipal services such as road maintenance, firefighters, police, public schools, and more. These taxes are imposed by the city in which you live and are calculated by the assessed value of your home, rather than the market value. This means your property taxes are based off what your home is worth (set by a property assessor) rather than what you paid (the market value).
The funds for property taxes are held in an escrow account until the time comes for the taxes to be paid. An escrow account is a savings account that is managed by your lender. You pay into this account as a part of your monthly mortgage payment. The lender then uses these funds to pay your property taxes on your behalf.
It is important to note that property taxes can change annually, which will cause your mortgage payment to change year to year.
Homeowner’s insurance is also a part of the mortgage payment and is held in escrow until the bill is due. Property insurance protects the home and its contents from fire, theft, and other disasters. Homeowner’s insurance is one part of a mortgage payment that homeowners have control over at any time. Be sure to shop around and compare insurance policies to get the coverage and payment that is best for you.
Private Mortgage Insurance (PMI) could be factored into your monthly payment as well. PMI is mandatory if you pay less than 20% down on your home. It protects the lender in the event the borrower is unable to repay the loan. Once you hit 20%, the PMI is taken off your mortgage payments.
You don’t necessarily need to include taxes or insurance into your mortgage payments, but it is a common requirement by your lender. If you choose to skip the escrow, you will need to make sure to pay these bills separately from your mortgage.
If you’re still unsure about potential mortgage payments, schedule an appointment with an FSB Home Loan Expert. They can help you break down all the pieces and have a better understanding of your future payments.