Mortgage Payment

What Goes into A Mortgage Payment?

Understanding Your Home Loan

Wondering what goes into your monthly home loan payment but don’t speak mortgage-ese? Our team at Southern Trust Mortgage has you covered. In this article, we’ll share everything you need to know about the two biggest components of your mortgage payments, the principal and interest, help you determine what you owe or will pay, and discuss the other factors that add to your payments.

Let’s dive in.

What is The Principal Amount?

The principal is simply the total amount borrowed during a mortgage loan transaction. It is the most important factor in deciding how much home you can afford and begins accumulating interest as soon as you take it out. More on that later.

If you aren’t sure how much home you can afford, a good place to begin is with a mortgage calculator. Simply enter the home value, loan amount, and a few other factors. The Southern Trust Mortgage calculator will then give you a rough estimate of your monthly payment! 

What is Interest?

The second major part of your monthly mortgage payment is interest. Interest is money you pay to your lender in exchange for granting you the funds. Most lenders calculate and determine your mortgage rate in terms of an annual percentage rate (APR). APR is the actual amount of interest that you pay on your loan per year (APR includes your mortgage rate and fees/costs). At the beginning of your loan (when your principal is high), most of your monthly payment goes toward paying off interest.

When it comes to interest, just a few percentage points can make a huge difference in how much you will pay throughout the life of your loan. Let’s say you borrow $150,000 at a 4% interest on a 30-year loan. With these loan terms, your monthly payment would be $716. If you take the same loan with a 6% interest rate, you’d pay $899 each month. 

 According to this example, just 2% difference resulted in nearly $200 more a month in payments!

How Are Interest Rates Determined?

Mortgage interest rates are determined based on both your qualifying factors and the current market rates. Let’s start with the one you can control: your personal factors. Simply put, the better your qualifying factors, the better the interest rate a lender can offer. Your credit score, home location, income, down payment, and occupancy status can all affect the interest rate you are given.

But you might ask, where do lenders get these numbers from? It all starts with the current market rates. Mortgage rates are affected by the overall economy, and when the economic outlook is good, rates tend to increase, and vice-versa. It seems somewhat backward, but it makes total sense from an economic standpoint.

When the economy is thriving, borrowers can afford more. Conversely, when it declines and unemployment rates increase, interest rates fall to make it more affordable for borrowers to take out loans.

Therefore, even though there’s not much you can do about market conditions, you can control the qualifying factors lenders take into consideration when you’re applying for a home loan. Keep your qualifying factors in tip-top shape, and you’ll be well on your way to scoring a great interest rate!

Could My Mortgage Payments Change?

In most cases, you’ll pay the same amount in your mortgage payment each month until you pay off your loan. However, there are two instances where your monthly payment (or the number of years you must pay your mortgage) may change. This is when you choose an adjustable-rate mortgage (ARM) and when you make advanced payments on your loan.

Adjustable-Rate Mortgage (ARM)

An adjustable-rate mortgage also called an ARM, is a home loan with an interest rate that adjusts over time based on the market. Usually, you’ll enjoy a few years of low fixed interest rates, but when that introductory period ends, your rates will fluctuate based on market trends. This means if market rates increase, your rate will also increase. In this case, your monthly mortgage payment will change because your interest rate depends on the market. 

It’s important to keep this in mind when applying for an ARM loan, and to ensure you have sufficient funds available in case of a rate increase!

Making Advanced Payments 

Your monthly mortgage payment can also change if you make additional payments on your loan. This is because you only need to pay interest on the amount of money you owe. This process, called “mortgage amortization,” gradually reduces your principal and what you owe in interest.

Paying just a little extra money each month on your principal can save you thousands over your loan term or even decrease the number of years until you must pay it off. 

For example, let’s say you have a $150,000 loan with a 4% interest rate and a 30-year term. Your monthly mortgage payment would be $716.12. Paying an extra $100 a month would reduce the amount of interest you pay throughout your loan by $25,205.78. You would also pay off your loan 6 years earlier than you would if you made no extra payments!

Consider budgeting some extra money each month to make an additional payment toward your principal balance, it could save you boatloads of cash in the long run!

What Else is Included in Your Monthly Payment?

Some borrowers tend to get tunnel vision on the principal and interest without considering other factors that could influence how much they’re paying each month. There are indeed home loans where you’ll only need to pay principal and interest to your lender, but your mortgage might also involve things like insurance and taxes.

Insurance

The two main types of insurance that can factor into your mortgage payments:

Homeowners insurance: Homeowner’s insurance works as a safety net to protect your home and finances in the event of an environmental disaster or an accident on your property. If something were to happen, your homeowner’s insurance would typically cover the cost of repairs to bring your property value back to where it was before.

Mortgage insurance: Mortgage insurance doesn't apply to everyone, but if you can't make a sizable down payment on your home, you'll likely have to pay a premium. Since low down payments are risky for lenders, they might require mortgage insurance to cover their investment if the loan goes into default. Depending on the type of home loan you have, you might pay private mortgage insurance (PMI) or a mortgage insurance premium (MIP).

Along with taxes, the insurance portion of your mortgage payment may go into an escrow account to pay back those costs.

Taxes

Regardless of where you live, you'll have to pay property tax on your home. The amount you pay is based on a percentage of your property value, which can change from year to year. The actual amount you pay depends on several factors, including the assessed value of your home and local tax rates. Typically, every county has a taxation system.

If the assessed value – not necessarily the same as the market value – of your property increases, the taxes you pay on your property will increase with it.

The Bottom Line

A home is often the biggest purchase our borrowers will make in their lifetime, so you can never be too prepared. Knowing what goes into a home loan and how you can manage payments will better prime you for the future and reduce surprises.

Are you ready to start your homebuying journey? We’re ready to make it happen. Connect with one of our skilled Loan Officers today.