What Goes Into A Monthly Mortgage Payment?
As a first-time homebuyer, you’ve got a lot on your mind. From saving up for a down payment and closing costs to attending open houses, making offers (and more offers), signing paperwork, and packing up a moving truck, your mortgage payment is the last thing on your mind. With that new homeowner glimmer in your eyes, it can be tempting to gloss over the details. But what really goes into a monthly mortgage payment anyways? Do you actually know? The answers may surprise you, and they are definitely worth understanding. Here is a no-nonsense breakdown of housing payments.
The 4 Pieces Of A Monthly Mortgage Payment
Monthly mortgage payments are not simply principal plus interest, as many people believe. Mortgage payments are actually composed of four pieces: principal, interest, taxes, and insurance.
If you have ever taken out a student loan, a car loan, or a personal loan, then you’re likely familiar with the term principal. The principal is the amount you’ve borrowed from a bank before any other taxes, fees, or interest is tacked on. If you purchased a home for $500,000 with $50,000 down, your principal would be $450,000, i.e., the amount the lending company is loaning you for your purchase. The principal is spread out over the life of your loan, which can vary but is commonly 30 years.
When you first start paying a mortgage, the amount of principal you pay each month is relatively low. As the loan matures, more of your monthly payment will go toward the remaining principal amount.
Interest is the percentage of the principal you pay to your lender each month. It’s essentially the “cost of borrowing money.” As a new homebuyer, you’ve likely thought long and hard about your loan program and interest rates, and for a good reason. Interest is a significant part of your monthly mortgage payment. Currently, mortgage interest rates are creeping up to 5% or more.
Luckily, the amount of your monthly payment that goes to interest will continue to decrease as you pay down your loan. You can also, in many cases, claim a mortgage interest deduction on your taxes to further soften the blow.
If you have a fixed-rate mortgage, the interest every month will remain the same for the life of the loan. If you have an adjustable-rate mortgage, the interest you pay will change (up or down) with market conditions.
No matter where you live, you'll pay some kind of property tax on your home. There are some states that tax more than others, however. For example, New Jersey has one of the highest property tax rates in the country.
In any state, though, the amount you pay is based on the assessed value of your home multiplied by your area's tax rate. In 2020 the average single-family home in the United States had $3,719 in property taxes, for an effective rate of 1.1%. Ultimately, if the value of your home goes up, so too will your taxes.
The last component of a monthly mortgage payment is insurance, specifically homeowners and mortgage insurance. The advantage of VA loans is that they don't require private mortgage insurance (PMI) but do require a VA funding fee at closing and homeowners insurance.
Homeowners insurance protects your home in the event of an environmental disaster or an accident on your property. If your home has earthquake damage, your homeowners' insurance would typically cover the cost of repairs to bring your property value back to where it was before the damage occurred.
Mortgage insurance comes into play for those without VA loans and a significant down payment. Since low down payments are risky for lenders, you will need to have mortgage insurance to cover their investment if the loan goes into default. Depending on your home loan type, you might pay private mortgage insurance (PMI) or a mortgage insurance premium (MIP).
The average monthly mortgage payment is $1,487, according to 2019 data from the U.S. Census Bureau's American Housing Survey.
If you want to know how much your monthly mortgage payment could be, get started here.
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