Recently I had one of my really close friends ask me “so what exactly do you pay with a mortgage?” At first my friend thought that my insurance, taxes, and PMI were all separate and in addition to my mortgage, to which I explained that a mortgage payment has many different components that go to different accounts. This confusion got me thinking, how many people my age know about mortgages? I mean, at some point or another, most of us will end up purchasing a home, so why does no one take the time to teach us the basics? Luckily for you all, I am here to briefly explain what the heck actually goes into your monthly mortgage payment.
What the heck is a mortgage anyways?
Good question! Your mortgage payments are a monthly payment that is payed toward the lender that holds your current loan. For example, my mortgage is with Wells Fargo, which means Wells Fargo holds my loan, and every month I pay them my mortgage payment.
So what goes into a mortgage payment?
Unlike rent which basically covers the cost of you living in that space, a mortgage payment jumbles many different components into one monthly payment. Your mortgage is comprised of Principle, Interest, Taxes and Insurance, the acronym used to remember this fun fact is PITI.
Now, let’s dive a little deeper into each expense.
This is the amount of money that goes directly to paying off the remaining balance of your loan. So for example, if your loan amount is $230,000 and your mortgage has $750 that is allocated towards the principle that means that every month you are paying $750 to towards paying off the loan.
hates loves interest. This is the amount of money that is charged for borrowing money. Most of the time, you are paying more toward interest than to the principal (story of our lives, right?)
Another subject everyone loves, taxes! Unlike renting where you don’t pay property taxes, your mortgage payment includes a portion that goes into an escrow (savings) account that is used by your lender to pay your property taxes each year. Taxes are based on how much your property appraiser has valued your home to be (this is a super complicated topic that we will cover in another post). The total yearly taxes are divided into 12 monthly payments and it is added to your mortgage.
You can’t buy a home without it (seriously, unless you’re paying for it in cash). Most of the time if you are a renter, you’re paying renters insurance separately and that is not included in your monthly rent; whereas, when you own a home, your monthly mortgage also includes a portion that goes towards your homeowners insurance. Sometimes this insurance portion goes into the same escrow account as your taxes and it gets paid off in full at the end of the year.
Bonus: Private Mortgage Insurance (PMI)
For those of us that do not have rich parents to give us 20% down payment for a home, we have to resort to putting less down and getting private mortgage insurance. This is a monthly payment that is made to your lender that helps them mitigate the risk of such a low down payment. This pesky little insurance is also a component of your mortgage if you have to get it. But it’s not too bad since it gives you the ability to buy a home with less cash for a down payment.
So there you have it, a mortgage in a nutshell. I hope this helps you better understand what you would be paying on a monthly basis when you have a mortgage and understand that as much as we would love to pay $2,000 to the principal amount, the actual amount is ridiculously small (which is why they give us basically 30 years to pay it off).