When you go out for dinner, the amount you owe is based upon what you order off the menu. If you select a large entrée or one made with specialty ingredients and drink a cocktail or two, for instance, you’ll pay more than if you chose a couple small plates and a glass of iced tea.
The way your lender calculates your mortgage is similar. Home loans aren’t one-size-fits-all borrowers. Nor is your payment simply the amount of your loan divided by its amortization period (the length of time it’ll take you to pay off your entire mortgage).
Instead, numerous factors (i.e. the items you choose from a menu) are taken into consideration to determine how much you owe each month.
What components make up a mortgage payment?
To calculate the bill for your meal, a restaurant totals the cost of your food and drink and sales tax, plus a tip if you’re so inclined. Likewise, your mortgage payment primarily consists of several items: loan principal, interest, taxes, and insurance. This list is sometimes referred to by the acronym PITI.
Your loan principal can be regarded as the food portion of your bill. Over the lifetime of your loan, this expense makes up the bulk of your mortgage payment.
The tax portion of your mortgage payment is like, well, the sales tax portion of your meal check. Look at the insurance portion as corresponding to the drink part of your bill and the interest as the tip. After all, its amount is calculated by taking a percentage (the interest rate) of your outstanding loan balance. Just like how you might calculate the amount you’d leave the wait staff for good service.
Are there other costs that could be included in my mortgage payment?
If your loan-to-value ratio — the percentage of your property’s value that you’ll be borrowing through your mortgage in relation to its total costs — is greater than 80 percent, your lender will probably require you to have private mortgage insurance (PMI) or mortgage insurance protection (MIP). PMI protects your lender in the event of you, as the borrower, ever stop making mortgage payments on the loan. MIP provides similar protection and is required for FHA loans.
If you’re purchasing a condo or home in a Planned Unit Development (PUD), then you may need to pay homeowners’ association (HOA) dues as part of your mortgage payment. These can be either monthly or annual and typically go towards the upkeep of common areas or buildings.
Consider these additional fees as the dessert portion of your dinner check — sometimes a must, but something you can pass on in many instances.
Does my mortgage payment stay the same the entire time?
The amount you owe can fluctuate from year to year. The cities and counties that levy property taxes review them annually and sometimes raise or lower them. Likewise, insurance providers analyze homeowner policies and might make adjustments to their cost. When this happens, your payment amount will be adjusted accordingly.
The type of mortgage you have can affect your monthly payments as well. Unlike a fixed-rate mortgage, whose interest rate is locked for the entire life of the loan, the interest rate on an adjustable rate mortgage (ARM) can be changed by your lender, usually after five, seven, or 10 years. Lucky for you, periodic and lifetime caps on interest rate increases limit the percentage your interest rate can increase at a single time, as well as over the life of your loan.
This can be confusing, so think of an ARM like a dish on the menu whose price is listed as “market.” The cost may remain consistent for a while, but changes in the marketplace could cause it to go up or down.
The amount of your monthly mortgage payment may seem mysterious at first. That’s why it can be helpful to compare it to a restaurant bill.
Ultimately, the amount you owe depends upon what you get. Waiter, I’ll take my mortgage now please.
Use Ally’s mortgage payment calculator to understand how variables to a home loan can impact your payment.