Even if you’ve never purchased a home or applied for a mortgage, everyone knows you will eventually deal with a mortgage payment.
However, not everyone knows the definition of a mortgage, what components make up a mortgage payment, or what goes into calculating the parts.
This article is designed to break down the different parts that make up a mortgage payment and give you the ultimate list of how you can achieve your first new home.
So let’s take a look!
What Is A Mortgage?
A mortgage is a distinctive type of loan used to pay for a portion of the cost of real estate.
Mortgages require a regular schedule of repayments, known as your mortgage payments.
The real estate you’re attempting to purchase is considered collateral on the loan. If the borrower cannot or does not make their mortgage payments on a timely basis, the lender will likely seize the collateral and sell it to repay the balance owed.
Lenders can come in different forms, from private individuals to major corporations and everything in-between.
The most common lenders are banks and mortgage specialty companies like River City Mortgage. Specialty lenders concentrate their expertise, skills, and resources specifically on the complex world of mortgages.
Typically due on a monthly basis, mortgage payments are set at an agreed-to amount by both parties, the lender and the borrower.
Now, let’s look at the parts of the mortgage payment itself.
Mortgage Payment Part 1: Principal
The principal refers to the amount of debt borrowed initially when the mortgage application was approved and remains unpaid.
The principal amount doesn’t include any accumulated unpaid interest associated with the debt.
In general, the principal is the central part of the monthly payment. A portion of the principal will be included in all the mortgage payments for the lifetime of the loan.
Here’s an example of the principal portion of a mortgage:
Say you purchase a home for $150,000 with a downpayment of 20%. The lender is loaning you the remaining 80% purchase price, or $120,000. That remaining $120k is the principal. Pretty simple, yes?
Side note: the term ‘Principal’ can also refer to the chief participant in a business transaction or contract. Make sure you don’t confuse the two terms.
Mortgage Payment Part 2: Interest Rate
Interest rates are a percentage of the principal portion of a loan.
For example, let’s say the mortgage agreement for your new home states the interest rate is 6% and the principal owing is $120,000 (same as the example above). That means your annual interest payment is $7,200, or $600 a month.
A typical interest rate is derived from the market interest rate and the lenders’ perceived ability to pay back the mortgage.
A fixed-rate mortgage is the most common variety of interest rates, which locks in a set interest rate for the loan duration.
The other most common is the adjustable-rate loan which fluctuates with the prime rate (an interest rate given by major banks to their best customers). These are riskier loans for the borrower because a spike in the prime rate can substantially increase mortgage payment amounts.
When considering the right time to purchase your first home, it’s a good idea to keep an eye on the mortgage rates and news feeds regarding mortgages. Changes in interest rates and mortgage trends can make a big difference in your timing to buy or wait.
Mortgage Payment Part 3: Taxes
Yes, you have to pay taxes – no surprise there.
The taxes you pay are used to fund schools, fire services, police services, and so on, in the community of your new home. The taxes may be due annually, semi-annually, or quarterly, depending on your municipality.
One option for payment is to establish an escrow account with your lender.
The lender sets aside a portion of your total mortgage payment per month specifically for the taxes. Then, as the tax payment comes due, the lender can pay it on your behalf out of that escrow account.
Each mortgage payment contains one-twelfth (1/12) of your annual bill amount. However, keep in mind that your lender has zero control over the amount of tax that you owe.
Mortgage Payment Part 4: Insurance
Insurance in a mortgage payment comes in two forms: Private and Homeowners.
Private Mortgage Insurance
Like many first-time homebuyers, you might be offering a downpayment of less than 20%. If that’s the case, then your mortgage program will almost certainly require you to purchase mortgage insurance.
Private Mortgage Insurance (PMI) protects the lender in the (hopefully) unlikely situation that the borrower defaults on their loan and can’t pay it back. PMIs are generally only required on loans with smaller down payments.
A home is likely to be one of the most expensive purchases you will buy in your lifetime. So it makes sense to ensure that value is protected by homeowners insurance.
This type of insurance is specifically for unexpected losses and damage to your property. When applying for a mortgage, a lender will want to make sure a homeowners insurance policy protects your home.
A lender will almost always require proof of homeowners insurance to cover the cost of repairs and bring the property’s value back to where it was before the accident.
An often overlooked part of a mortgage is the pre-approval. Completing the pre-approval process is one of the simplest and fastest ways to improve your chances of getting the home you want.
What is pre-approval?
Mortgage pre-approval demonstrates to a seller that you are qualified for a loan of a certain amount at a specific interest rate. A mortgage pre-approval comes from a qualified lender like River City Mortgage.
Why do you need it?
Before you even contact a realtor, it’s a good idea to apply for pre-approval. In a competitive housing market, many sellers won’t even look at your offer unless it’s accompanied by a pre-approval letter.
Pre-approval also gives you a clearer idea of what you can afford for your monthly mortgage payments.
River City Mortgage puts their seal of approval on your mortgage application, which can help your application ascend to the top of the pile of offers the seller has to consider. The River City Seal of Approval shows the seller that your application was reviewed by our most senior-level mortgage specialists.
How much does pre-approval cost?
It’s free! And it’s quick!
A pre-approval letter is valid for 30 to 90 days to help you search for that perfect home.
Even if you’re just curious about how much of a mortgage you might qualify for, reach out to one of the licensed loan officers at River City Mortgage.
It could be the smartest choice you make in the home-buying adventure.