How will my monthly payments be calculated?

How much you will pay each month will depend a lot on the term of your loan. That is, how long do you plan on paying the loan back. Most mortgages are either 30-year or 15-year terms. Longer term loans require less to be paid back each month; whereas shorter terms require larger monthly payments, but pay off the debt more quickly.

Most monthly payments are based on four factors: Principal, Interest, Taxes and Insurance, commonly referred to as PITI.

  • Principal: This is the amount originally borrowed to buy a home. A portion of each monthly payment goes to paying this amount back. In the beginning, only a small fraction of the monthly payment will be applied to the principal balance. The amount applied to the principal will then increase until the final years when most of the payment is applied toward repaying the principal.
  • Interest: To take on the risk of lending money, a lender will charge interest. This is known as the interest rate, and it has a very direct impact on monthly payments. The higher the interest rate is, the higher the monthly payment.
  • Taxes: While real estate taxes are due once a year, many mortgage payments include 1/12th of the expected tax bill and collect that amount along with the principal and interest payment. This amount is placed in escrow until the time the tax bill is due. Borrowers may be able to opt-out of escrowing this amount, which would reduce the monthly payment, but also leave them responsible for paying taxes on their own.
  • Insurance: Insurance refers to property insurance, which covers damage to the home or property, and, if applicable, mortgage insurance. Mortgage insurance protects the lender in the event of default and is often required in cases where borrowers have less than 20% equity in the home.
  • Like real estate taxes, insurance payments are often collected with each mortgage payment and placed in escrow until the time the premium is due. Again, borrowers may be able to opt not to escrow the insurance amount, instead of paying the total amount due in one lump sum on their own.