The real estate industry is on fire and there are no signs of it slowing down. In spite of a supply crunch, mortgage applications still increased by more than 2% in the first week of May. Borrowers are taking advantage of near-record low mortgage rates. It is much cheaper to finance a home now than it was a decade or two ago.
Near-record low-interest rates led to a mortgage refinance boom over the past year. In fact, refinances accounted for up to 75% of all loan originations.
However, interest is just one component of your mortgage payment. Read on for a breakdown of your monthly mortgage payment.
What Is Included In Your Monthly Mortgage Payment?
Your mortgage consists of various different components that result in the final price. Not all mortgages have the same costs included depending on your down payment and other factors.
Some mortgage calculators provide home shoppers with a simple look at their monthly payment. This simple calculation only considers the loan term, interest rate, and loan amount.
However, the best mortgage calculators provide a more comprehensive look. Continue reading for a detailed breakout of all possible mortgage-related expenses on your monthly bill:
Principal is the element that the majority of homeowners are interested in. Each month you pay down the total amount that you owe on the home.
The amount of principal paid depends primarily on loan term and interest rate. A longer loan term is going to result in less payment going towards principal.
Borrowers that want to own their home outright faster are naturally going to select a shorter loan term. For them, a 10 or 15-year mortgage makes more sense. The borrower is able to build up equity at a much faster rate.
You can pay an additional principal on your mortgage each month. This is one effective strategy to paying down the loan balance faster and building your net worth.
Some borrowers elect for biweekly payments instead of monthly. This strategy results in making one additional payment towards principal each year. It can take years off your mortgage loan term.
After principal, another large percentage of your monthly payment goes towards interest. The interest rate on the loan is based on a number of different variables.
Again, the loan term partially drives the interest rate range. Shorter loan terms allow borrowers to secure a lower interest rate.
The interest rate is based on the borrower’s application. The lender reviews the applicant’s credit score and history to quote an interest rate.
The interest rate may also vary depending on the type. A fixed interest rate is locked for the duration of the loan term. However, variable rate changes based on market conditions.
Private Mortgage Insurance (PMI)
PMI is assessed on mortgages in which the borrower does not meet a 20% down payment requirement. There are many lending vehicles that do not require a 20% down payment including Federal Housing Administration (FHA) guaranteed loans. However, these loan types are at greater risk of default.
To mitigate the increased risk of default, lenders assess PMI on the loan.
PMI rates vary depending on several factors including borrower’s credit history, down payment percentage, and more. Traditionally, PMI rates range from 0.5% to 1.5% of the total loan amount.
While some borrowers pay PMI upfront during the closing, it is commonly added as a premium to the monthly mortgage payment. It is calculated by multiplying the PMI rate by the loan amount. This annual value is then divided by 12 to calculate the monthly premium.
Some of the record-setting refinance activity is driven by a desire to eliminate PMI. With home prices soaring, a growing number of homeowners have a 20%-plus equity stake in their home. With a refinance, they can drop their PMI and reduce their monthly payment.
Property taxes are assessed by your local government. They cover local services such as public schooling and park maintenance.
It is possible for property taxes to be included in your mortgage. This occurs when a borrower is required to use an escrow account. In some cases, a borrower elects to use an escrow account even if it is not required.
Escrow can be waived for borrowers who put down 20%. Borrowers who elect to waive an escrow account pay their local government directly. Therefore, property taxes are not included in their mortgage.
For borrowers with an escrow account, their annual property tax obligation is divided by 12 months. It is then added to their monthly payment. The money is then routed into escrow and the lender makes the property tax payments for the borrower.
Home insurance falls into a similar category as property taxes. It is paid out of your escrow account.
Your monthly obligation is driven by the annual home insurance premium. The lender divides your annual insurance premium by 12 months. This monthly amount is then added to your total mortgage.
Like property taxes, this money is also routed into the escrow account. The lender then makes a one-time premium payment for home insurance.
If the escrow account is waived, the homeowner is responsible for handling home insurance separately. Many borrowers like to maintain escrow even when it is not required. When the lender handles property tax and home insurance, the process is seamless and payments are never late.
Your mortgage amount may vary if certain fees are assessed. For example, you may be assessed with a late fee if you miss a monthly payment.
All potential fees are documented in your loan’s terms and conditions. If you see a fee added to your monthly bill, review the terms and conditions to check its validity.
Breaking Down the Components of Your Mortgage
We have now covered the major elements of a monthly mortgage payment. Principal and interest are standard on every mortgage.
Components such as PMI vary depending on the loan. If you use an escrow account, property taxes and home insurance are certain to be included.
If you have any questions about what is included in a mortgage payment, contact us today to speak with a loan specialist.