What Makes Up a Monthly Mortgage Payment?

Principle

Your loan principal is the outstanding balance of your mortgage, or the amount you borrowed minus how much you’ve already repaid. As you make payments, your principal is reduced until you’ve fully reimbursed your lender. How much principal your monthly bill includes is determined by the term of your loan agreement. However, you can pay down your loan faster by increasing how much you put toward your principal each month or by making lump sum payments periodically.

Paying your down principal also helps you build home equity, which is the difference between your mortgage balance and your home’s market value. A benefit of having equity in your home is that you can borrow against it to obtain funds for other financial needs.

Interest

In addition to principal, your mortgage payment will also include interest, or a percentage fee charged on your loan balance. It is essentially the cost of borrowing money from your lender. 

Depending on your mortgage agreement, you may have a fixed or variable interest rate. Several factors usually contribute to how your lender determines your interest rate, including your credit score, type of loan, down payment amount and market rates.

With a fixed interest rate, more of your mortgage initially goes toward interest. But as your loan matures, more of your monthly payment will go toward the principal. The amount you pay in interest will shrink alongside your balance until you’ve fully repaid your loan. Interest rates for adjustable-rate mortgages, however, can change over time based on market indexes.

Fund Escrow Account

Your lender may have you open an escrow account to ensure certain bills related to your property are paid on time. Those usually include property taxes, homeowners insurance and private mortgage insurance. The portion of your mortgage payments earmarked for such items will go into the escrow account. Then, your lender will use the account to pay your bills when they are due.

Using an escrow account is a way to protect your investment in your home. It reduces the risk of you defaulting on your loan or incurring liens and helps you avoid penalty fees or foreclosure. Plus, you get the convenience of paying just one bill each month.

If your mortgage does not have an escrow account, you would be responsible for paying for making these payments when they were due.  

Property Taxes

Nearly all homeowners pay property taxes on their homes, another item included in most mortgage payments as part of the escrow charges. Property taxes are levied by state and local governments, and they are based on your home’s assessed value and your local tax rate. The taxes usually fund public works, such as schools, infrastructure and safety services. Your local tax agency may collect property taxes annually, biannually or quarterly, and your lender will make the payments for you using your escrow account.

As property values change, so can the amount you owe in taxes for your home. That means you could see your monthly mortgage payment increase if your home’s assessed value and the property taxes owed on it are raised. Your local municipalities will periodically update your home’s assessed value and notify you of any changes to your taxes owed going forward.

Homeowners Insurance

While you may not legally have to purchase homeowners insurance, it is required by most lenders if you have a mortgage. Even if you own your home outright, it is still a good idea to have homeowners insurance because it covers unexpected damage to or loss of your home.  You normally select a policy with a private insurance company of your choosing, and the cost will be added to your mortgage payments. Your lender will then pay your premiums with money from your escrow account.
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The cost of your policy will depend on the age and location of your home and other factors, such as security systems and what extent of coverage you need.  Prices can fluctuate annually. However, standard policies don’t typically cover damage from floods or earthquakes, and coverage of the belongings in your home will be limited.

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Private Mortgage Insurance

Like property taxes and homeowners insurance, premiums for private mortgage insurance, often referred to as PMI, may also be included in your mortgage and paid via your escrow account monthly. Homeowners who take out a conventional loan with a down payment of less than 20% of the home sale price are usually required to purchase private mortgage insurance.

Although you buy it, this type of insurance isn’t actually for you. Instead, it’s intended to protect the lender in case you default on your loan. If that happens, the private mortgage insurance policy covers a portion of the balance you owe your lender. You could still lose your home through foreclosure though, as these policies do not protect you.

Private mortgage insurance can help buyers qualify for loans they may not otherwise be approved for.  Your lender will likely arrange a policy for you with a private insurance company. Once your loan balance drops to 78% of your home’s worth, your policy will be terminated and you will no longer have to pay for it.

You can avoid the extra expense, however, if you are able to put a down payment of 20% or more, when you purchase your home.