Have you ever stopped to look at your mortgage statement? You may notice there are several different numbers aside from the total you pay each month. While paying a single monthly amount seems reasonable, you would be better served by understanding how that amount is split up by the mortgage company that receives it.
As you become educated about the various elements of your statement, you may find there are easier ways to pay off your loan and potentially save yourself some money in the long run.
What does your mortgage payment really include? Let’s take a look.
The principle is the value of the loan you received from your bank or lender. The value does not reflect the interest or any fees. If you borrowed $250,000, then your principle at the time of the loan was $250,000. As you make mortgage payments over the years, the principle on your statement will shrink as a portion of your payment is applied to it.
Some new homeowners are surprised to learn how little of their payment goes toward paying down the principle in the early years of the loan. Mortgage banks weight the loan payment more heavily toward interest than principle during the first payments. As time goes on, the payment becomes weighted more toward principal in the final years of payments.
Most lenders provide ways for you to pay additional money towards the principle, which can shorten the term of the loan and save some money over time.
As with any loan, you also pay interest on the amount you borrowed. When you were applying for loans, you looked for the lowest interest rate you could find to decrease your monthly payment and the total amount you paid the bank over and above the loan amount.
The interest rate you are charged depends on several factors, but the variation tends to occur due to the amount of risk the bank thinks it is taking on by loaning you the money. A mediocre credit score indicates the bank may be taking on more risk than if you have an excellent credit score. Other factors impacting the interest rate include the amount of down payment you place on the loan, the loan program, the type of property, and the loan to value.
Loan to value is calculated by dividing your loan amount by the purchase price (value of the property). The lower the number, the lower the associated risk.
Your monthly payment amount may vary according to the type of loan you receive. Different types of loans treat the repayment of principal and interest differently.
- A fixed rate mortgage will charge the same percentage of interest for every payment throughout the life of the loan regardless of the economic index or federal interest rate.
- An adjustable rate mortgage is one in which the interest payment varies depending on the federal interest rate. If the federal rate goes up, so does the interest on your loan and you will have a higher payment. On the other hand, if the economic index goes down, so does the interest charge and your payment.
- A balloon payment is the final payment in a loan where you pay a set amount each month for a specific number of months and then must pay the remainder of the loan all at once. It’s called a balloon loan because the final payment is usually much larger than the previous monthly payments.
Like paying additional to principle, you can pay more against interest, but there isn't much reason to do so.
Taxes are one of those things you can’t escape (the other being death). Your county government determines a tax rate, sometimes known as a mill levy, to collect money for public services such as schools. The local government assesses the value of your property (which may not match the price you paid) and multiplies it by the tax rate to determine how much you must pay each year.
Taxes are paid once a year, but most mortgage companies establish an escrow account and place part of your payment in it each month to prepare for the annual tax assessment. Taxes can go up or down according to the local government that sets them. Your property assessment can change as well so you may not pay the same amount in taxes every year.
Your mortgage company is responsible for sending the money to the government.
Along with taxes, your escrow account accrues a portion of your payment for your homeowner’s insurance, which is also paid annually. Your homeowner’s insurance protects you against the event of an expensive repair or other expense.
If you were unable to put a substantial down payment on your home, you might also be paying Private Mortgage Insurance (PMI) to protect your lender in the event of a default. It is also part of your monthly payment.
A Word about Escrow
Lenders are required to keep a certain amount of cushion in your escrow account to guard against changes in taxes and insurance. Don’t expect your escrow to decrease to zero immediately after taxes and insurance are paid. Contact your lender to determine the amount of cushion required for your escrow account.
Also, because the lender is estimating how much tax and insurance you will pay the following year, you may be asked to pay an adjustment to keep your monthly payment the same. The adjustment is supposed to match the presumed taxes for the next year. Otherwise, the adjustment is added to your monthly payment, and it may increase even though you have a fixed rate mortgage.
The mortgage company also sends the insurance payment to your insurance company. Once you pay off your loan, it will be your responsibility to save up to pay both the taxes and insurance each year.
Tips for Paying Off Your Mortgage
You can save yourself some money by making the largest down payment you can afford on the property you buy. Then you will borrow less from the bank. A smaller loan may provide you a better interest rate. Also, if the down payment is large enough, you will not be required to pay Private Mortgage Insurance.
You can shorten the term of your loan by paying extra toward the principle every month. If there is no penalty for an early payoff, you will save a bundle on interest by shortening the loan period. If you are ready to make a final payment, always contact your lender for the final payoff amount since it won't necessarily be the same as the principal balance on your statement.
Applying for the shortest loan term you can manage also saves you money on interest. If you can afford the monthly payment on a 20-year loan, you will save a lot of cash over taking out a 30-year mortgage.
Understanding how your monthly mortgage payment is apportioned is part of being a savvy consumer. Monitor your statements for changes and call your bank if you don’t understand where your money is going.