Updated: Mar 4, 2021
When homeowners pay their mortgage payment every month, they aren’t simply sending a check to partially pay back their loan with interest. There are four components of most mortgage payments.
1. Principal: this is the portion that goes towards paying down the homeowner’s loan balance. Because of amortization, this amount is low at first and gets larger and larger over time.
2. Interest: this is what homeowners pay the lender (or owner of the mortgage) in exchange for them borrowing funds. Amortization is at play with interest too. The amount of interest paid is high at first and gets lower over time. This means lenders make most of their profit (interest) early in the loan term. Mortgage interest is tax deductible in the US, so if a taxpayer itemizes on their taxes, mortgage interest can lead to quite a deduction.
3. Taxes: these are the property taxes, and the funds are distributed to different taxing authorities. For example, our taxes go to the general fund, health department, county planning council, emergency medical service, county school board, local schools, our city, water management, juvenile welfare board, and the transit authority. In Florida, property taxes are approximately 1% of the purchase price of the home. Every month, homeowners pay a portion of their taxes, which go into an account. When taxes are due, the lender pays the homeowner’s property taxes from that account.
4. Insurance: if a homeowner has a loan on their property, the lender requires insurance. Homeowners insurance covers the buildings, possessions, and liability. For more information on homeowners insurance, please reference Homeowners Insurance Coverage 101.
Flood Insurance: some at-risk areas require flood insurance, per the Federal government. We deal with this a lot in Florida.
Private Mortgage Insurance (PMI): for conventional loans in which homeowners put down less than 20%, the homeowner pays a premium to an insurer and in exchange that insurer agrees to pay the mortgage off in the event of default. Once the homeowner has 20% equity in the home, they can request that PMI be dropped from their monthly payment.
Mortgage Insurance Premium (MIP): if a homeowner takes out an FHA loan to finance their home, they will pay a mortgage insurance premium up front and every month, which is similar to PMI (above). In some scenarios, MIP must be paid for the life of the loan.
If you're considering buying a home, remember that you'll be paying more than principal and interest. Your taxes and insurance will be a part of your payment as well.