How Mortgage Payments Work: Principal, Interest, Taxes and PMI

A mortgage is the biggest loan most people will ever take, and the monthly figure the lender quotes is often only part of what you will pay. This guide breaks the payment into its parts, shows how the down payment, term and rate change it, and explains how to budget for the whole cost of a home.

The parts of a mortgage payment

Lenders often describe the payment as PITI: principal, interest, taxes and insurance. Add PMI and HOA fees where they apply.

• Principal is the part that reduces the amount you owe.
• Interest is the cost of borrowing, charged on the remaining balance.
• Property tax is collected by your local government, usually as a percentage of the home value each year.
• Homeowners insurance protects the building, and lenders require it.
• PMI (private mortgage insurance) is charged when your down payment is below 20 percent of the price.
• HOA fees apply in some communities and are usually paid separately.

Taxes and insurance are often paid into an escrow account with your mortgage payment, so the lender pays the bills for you.

An example with real numbers

A $400,000 home with 20 percent down ($80,000) needs a $320,000 loan. At 6.5 percent over 30 years, principal and interest are $2,022.62 a month. Add property tax of 1.1 percent of the price, or $366.67 a month, and insurance of $1,200 a year, or $100 a month, and the payment is about $2,489. Over the full 30 years you would pay about $408,000 in interest alone, more than the amount you borrowed.

The down payment and PMI

If you put down only $20,000 (5 percent), the loan is $380,000. Principal and interest rise to $2,401.86, and if PMI is 0.6 percent of the loan a year, another $190 a month is added, bringing the total with tax and insurance to about $3,059. PMI can usually be cancelled once your balance falls to 80 percent of the original price, which on this loan happens around month 124, or a little over ten years in.

A bigger down payment lowers the loan, the interest and the PMI, but it uses cash you may need for closing costs, moving and repairs. There is no single right amount; make sure you keep an emergency fund after paying.

Interest rate: small numbers, big money

On a $320,000 30-year loan, the monthly principal and interest is $1,816.92 at 5.5 percent, $2,022.62 at 6.5 percent and $2,237.49 at 7.5 percent. Each percentage point is worth roughly $200 a month, or about $75,000 over the life of the loan. Shopping around, improving your credit before applying and considering whether to pay points to lower the rate are worth the effort.

15 years or 30 years

A 15-year mortgage carries a higher payment and a lower rate. At 5.75 percent, the $320,000 loan costs $2,657.31 a month and $158,316 in interest, against $2,022.62 and $408,142 for the 30-year loan at 6.5 percent. The shorter loan costs $634.69 more each month and saves about $249,800 of interest.

Many buyers choose the 30-year loan for flexibility and pay extra when they can. Adding $200 a month to the 30-year loan ends it in 281 months instead of 360 and saves about $105,000 in interest, without committing you to the higher required payment.

How much can you afford?

Lenders check the front-end ratio (housing costs compared with gross income, often around 28 percent) and the back-end ratio (all debts, often 36 to 43 percent). For your own budget, start from what you are comfortable paying each month, remember maintenance (a common rule of thumb is 1 percent of the home value a year), and test prices until the full payment fits.

Common mistakes

• Judging a home by principal and interest only, then being surprised by taxes and insurance.
• Comparing loans by rate instead of APR and total cost.
• Stretching to the maximum a lender will approve rather than what fits your budget.
• Ignoring how a rate change or a rise in taxes and insurance would affect the payment.

Calculate your own mortgage

The Mortgage Calculator adds tax, insurance, PMI and HOA fees to the loan payment, shows the split in a chart, and compares extra payments. Use the Rent Affordability Calculator to compare with renting, the Loan Calculator for any other loan, and the Savings Goal Calculator to plan the down payment. For how loan payments work in general, see loan payments explained.