The Full Mortgage Payment: Looking at P&I and More
While overall costs is an important consideration, people are, for obvious reasons, concerned with the monthly costs of owning a home. For most, the mortgage payment is the main concern.
But even the mortgage payment itself can be complicated, and, over the course of a loan, the monthly total can change. While adjustable-rate mortgages can alter due to shifts in interest, fixed-rate mortgages can also change.
Whether you are planning on using a mortgage loan to purchase a home in the near future, or you already have a home loan in place, understanding your mortgage payment is crucial. With this knowledge, you will be a more informed homeowner.
What Goes into Your Mortgage Payment? More than Just P&I
Principle and Interest (P&I)
The first part of the payment is your principle and interest. For a most homebuyers, this is the largest part of the mortgage, and it tends to be the component that is the highest, usually by a factor of ten or more. While we could separate the two (treating principle and interest as two different categories), they are closely related and usually lumped together. For this reason, we’ll treat each part as a subcategory of P&I.
First is the principle. This is the part of your loan that actually goes to reducing the total amount you owe to the bank. In many ways, of all the components of your mortgage payment, it’s the most simple: for every dollar you pay in principle, the amount you owe is reduced by a dollar. However, the fraction of your payment that goes toward the principle is not always the same. At the start of your loan, the fraction of payment that goes towards the principle is not as high as it will be later in the loan, because of a of a process called “amortization.” (For more on amortization, see below.)
The other part if “P&I” is the interest. This is simply the additional money you agree to give the bank for the privilege of borrowing their money, without which most people would be unable to buy a home. The interest is based on a percentage, and the percentage is determined by many factors, including the type of loan, the borrower’s debt load, and the borrower’s credit score. For fixed-price loans, the interest rate does not change, but it will change (usually annually after an initial five- or ten-year period) for adjustable-rate mortgages.
Amortization is an accounting technique that steadily lowers the principle of a loan over a certain period. Basically, the first payment of a typical home loan is high on interest and lower on principle; in other words, the portion of the loan that goes towards interest is more, ensuring that, even if the loan if repaid early or disrupted for any reason, the bank is still compensated for the work they did while issuing the loan. For each payment, the portion of principle is increased; by the end of the loan the principle makes up almost the entirety of the payment.
To get a better understanding of amortization, see our previous article “How Amortization Impacts Your Fixed-Rate Loan”
Although it’s not part of every home loan, part of your mortgage payment may include insurance, including mortgage insurance. This is simply an insurance policy that protects the lender against a default on the loan, which can cost them tens of thousands of dollars. Somewhat ironically, the mortgage insurance protects the lender but is paid for by the borrower.
In most cases, mortgage insurance is required for any loan that has less than a 20% downpayment. For example, if you have a 5% downpayment, you may have to pay mortgage insurance until you have reached 20% equity.
Generally mortgage insurance is a relatively small payment, as the chances of default are, relatively speaking, lower risk. Usually mortgage insurance is about 0.5% to 1% of the total loan cost annually. So for every $100,000, you will pay about $1,000 a year in mortgage insurance until the loan is repaid.
It would seem that mortgage insurance only benefits the lender, but that’s not true. Thanks to the protections brought by mortgage insurance, banks are able to offer more loans to more borrowers. Without this insurance, some people may not be able to secure a home loan at all.
The other part of your mortgage is the taxes. The bank has a vested interest in making sure the homeowner pays their taxes, so much so that they often take on the burden of paying the property tax and rolling this cost into the mortgage.
When you have the taxes rolled into the mortgage, the bank will deposit a portion of the payment into an escrow account. This account is then used to pay for your property tax.
But why can’t you simply pay the taxes yourself? It would seem that paying the taxes directly, and not involving the bank, would save time, money, and hassle. But, as you may have noticed, banks like to protect their assets and reduce risk. By keeping money in escrow, the bank is able to pay the remaining tax burden in the event of a foreclosure.
Also, by paying the taxes as part of your mortgage, and letting the bank handle the rest, you are freeing yourself from having to shell out thousands of dollars in a lump-sum payment, which you may not be prepared for.
How much you pay in property taxes will depend on the local tax rate in your area, as well as the value of your property.
Creating Informed Borrowers Through Dedicated Service
Want more information on mortgage payments? At San Diego Purchase Loans, we believe in the value of informed, confident buyers. Contact our team today and we’ll help you find the right loan for your specific needs, and we’ll make sure you understand all the details of your mortgage payment!