How much house can you afford? It helps to know the four components of a monthly mortgage payment. They are the principal, interest, taxes and insurance.
Let’s take a closer look at each.
Mortgage payments include money dedicated to repaying the amount borrowed, known as the principal. For instance, if you borrow $200,000, that’s the principal. At the start of your mortgage’s term, your payments go largely to paying off the loan’s interest. As the term of the loan progresses, an increasing amount of money goes to pay down the principal.
Loaning money is always a risk, so lenders charge a percentage of the principal to offset that risk. Rates vary depending on the economy, but also based on the borrower’s credit-worthiness — a low credit score means more risk and a higher interest rate. Of course, higher interest rates mean higher monthly payments for borrowers.
Property taxes can be a big part of your mortgage payment, depending on where you’ve bought. That part of your monthly payment helps fund schools, city and county services and other local government functions. It’s based on the tax rate for each of those taxing authorities, applied to the appraised value of your property. Usually, you can pay the taxes in a lump sum every year or divide the bill over your 12 monthly payments.
Insurance payments also can be made with each monthly mortgage payment. It’s typically a requirement by the lender. You might also need private mortgage insurance (PMI), if you pay less than 20 percent of the property’s price as a down payment. PMI protects a lender in the event a borrower defaults on his or her loan.