With a home mortgage, you agree to make the monthly payment specified in the loan contract. And you’re payment essentially gets divided between the two basic components of the loan: principal and interest.
What is mortgage principal?
Your mortgage’s principal is the initial amount of money that you borrow for your home loan. It’s basically the selling price minus your down payment. If you purchased a home for $350,000 and made a $70, 000 down payment, the remaining $280,000, is your principal.
This is one of the most important numbers to consider when deciding if you can afford a home. The principal amount that you borrow from the lender is the amount upon which interest accrues as soon as you take out the loan.
Additional costs that begin to accumulate on top of your principal and interest include, but are not limited to, property taxes, maintenance and repair costs, homeowners insurance, additional insurances, dues, fees, and more.
What is an interest payment?
This is the second part of a mortgage loan after the principal. Interest is the money you agree to pay your lender because they gave you a home loan. Most lenders calculate interest using the annual percentage rate (APR) method. APR is the amount of interest you’ll pay on the loan per year.
While APR numbers may not seem that big, when you calculate their relation to the principal amount, just a few percentage points can make a massive difference over the course of a 15- to 30-year mortgage loan term. For example, someone borrowing $150,000 at 4.00% APR with a loan term of 30 years would have a monthly payment of $716.12. The same loan with a 6.00% APR increases the monthly payment to $899.33. After 30 years, the difference equates to more than $67,000 in interest alone.
The interest rate you’re able to arrange with a lender is dependent on many factors, including your income, credit score, and debt-to-income ratio, plus the amount that you put down on the property. Considering the vast difference in interest costs — even from a “mere” 2% — it’s smart to work on boosting your credit score as much as possible before starting the mortgage application process.
Are other costs included in my monthly payment?
This largely depends on your mortgage lender, but generally speaking, principal and interest comprise the majority of the mortgage payment. In some cases, lenders may include additional costs or fees such as insurance, taxes, and escrow. Let’s break it down a bit.
Insurance
There’s no legal requirement for home insurance, but most lenders will not give you a loan until you prove you have adequate homeowners insurance covering things like fire, theft, or storm damage.
Additional insurance policies can cover your home and property against natural hazards, such as earthquakes and flooding. Cost for homeowners insurance can vary, depending on factors such as the home’s value, location, neighborhood, or proximity to emergency services.
Taxes
Regardless of where you live, you’ll have to pay property taxes. These taxes go to local or municipal government to fund public services like schools, libraries, emergency services, and infrastructure projects. Do your homework to investigate and understand these potentially expensive costs.
A home appraisal conducted as part of the loan application process will help ensure that your property taxes are determined accurately. And savvy homebuyers should realize that property taxes can change from year to year.
Escrow
An escrow account is used by mortgage lenders who want to take a certain percentage of the payment and set it aside in the account to ensure that property taxes (and sometimes insurance costs) are paid in full and on time.
Is it possible to change the principal or interest?
With most mortgage contracts, you’ll pay the same amount each month until your loan is paid in full. One way your principal or interest could change is with an adjustable rate mortgage (ARM), where the interest rate is determined by the market’s ups or downs. It is also possible to “get ahead” by paying more than your required principal amount. If your agreement has no early payment penalties, you should be able to save on interest paid over time by cutting down on the repayment duration and the amount upon which the interest calculation is based.
