Mortgage Payments: Most Frequently Asked Questions

After you buy a home and have a mortgage loan, obviously you are expected to make monthly payments to pay it back. But often, there are other charges on the monthly mortgage statement that new homeowners may not be familiar with.

Below are many of the most frequently asked questions about mortgage payments. The information details some of the more common terms & charges that may be associated with your monthly mortgage payment, how those expenses may be determined, and whether or not they will change over time.

Have questions about your mortgage? Always consult with your mortgage lender for advice specific to your needs.

What is Mortgage Principal ?

The principal amount of a mortgage is the total sum that was borrowed, and how much of that amount is left. If you have a fixed-rate mortgage, the lender calculates a monthly payment based on the interest rate and the length of the term.

In this type of loan, the principal and the interest paid both change over time. In the beginning, you will pay more interest than principal each month, though the combined total of both the principal and interest (the mortgage payment) will remain the same over the life of the loan.

Each month, the payment to the principal gradually increases. Eventually, the amount of principal reaches zero, and you have paid off the loan. After you closed on your home, you were likely supplied with an amortization schedule. If not, your lender should be able to send you one. The amortization schedule will show you how much principal and interest you are paying each month.

What is an Interest-Only Loan?

Some types of mortgage handle the payment of principal differently than a standard fixed-rate type mortgage. With an interest-only mortgage loan, for a set period of time, you pay only interest and no principal on the loan. At the end of the term, your loan may change to a fixed-rate or adjustable-rate mortgage, depending on the details of the loan.

What is an Adjustable Rate Mortgage?

With an adjustable-rate mortgage, the interest rate fluctuates, but the principal still goes down gradually. At periods specified in the loan (e.g. six months or a year), your lender will alter the monthly payment based on a new interest rate, calculated to pay off the principal entirely by the end of the loan term. This interest rate is based on the system for calculation (an index) and is detailed in the mortgage documents - most likely based upon treasuries, the Libor Rate or Prime Rate.

In most cases, if these indexes rise, then the interest you will be charged each month will increase. As a result, the monthly mortgage payment also goes up as well. However, should general interest rates decrease, then more than likely the monthly mortgage payment may also decrease.

How is Mortgage Interest Calculated?

Your annual percentage rate (APR) of interest on your mortgage loan determines how much interest you will be charged each year on the principal you still owe. Since interest rates are shown as an annual percentage rate, the amount of interest on a loan is divided up into 12 monthly payments, though these payments to interest may not be the same amounts, depending on the amortization schedule. For example, on the first year of an $180,000 loan with a 4 percent APR, the interest for the year will be $7,200. 

However, the interest calculation changes as the principal amount changes. With a fixed-rate loan you will not be paying the same amount of interest each month, though your principal plus interest payment will remain the same each month. This is because the amount paid to principal goes up each month while the amount applied to interest goes down. Your amortization schedule shows how much interest and principal you will be paying each month.

How are Property Taxes Calculated?

Unlike the principal and interest on a mortgage, which are based on the original loan documents, property taxes are based on a specific value of your home, known as an "assessed value." Property taxes provide tax revenue to state and local services. Often, property taxes are the main source of revenue for public schools. Property taxes are calculated based on the assessed value of your home. This assessed value may be greater than, equal to or less than the current market value of the home.

Taxing entities that rely on property taxes for revenue, such as city, county and some local public institutions such as schools, determine what they need from property taxes in order to operate and function. The total property value in the region is tallied, and then that number is divided by the amounts needed by all relevant parties to determine tax rate.

Since state legislatures and local governments determine their needs independently, property tax rates can vary quite distinctly from county to county, and from state to state. So not only will the home's assessed value go up or down each year, the combined property tax rate will adjust as well. 

How Are Home Values Assessed?

There are many ways to estimate the value of your home, and what you paid for it does not necessarily determine how much you will owe in property taxes. Instead, your county assessor relies upon the assessed value of the home. Each year, the county determines the value of your home, based on a number of factors. If the assessed value of your home increases or decreases, your property taxes may also change.

Most homeowners receive a statement each year showing the tax assessed value for their home. Should you disagree with amount, there are usually ways of contesting this amount. Refer to the statement or contact your county tax assessor as to how to contest your home's assessed value.   

How Are Property Taxes Paid?

Most mortgage lenders add an escrow payment to the monthly principal and interest payment. All or part of this escrow payment will be for the estimated property taxes for the coming year. The actual or estimated property taxes for the year are divided by 12 and then paid with the mortgage payment.

While some homeowners with a mortgage will have the option of paying their property taxes directly, for most borrowers, the lender usually makes tax payments on the behalf of the borrower.

Is Homeowners Insurance Part of a Mortgage Payment?

In addition to the payment of property taxes through the monthly escrow payment, mortgage lenders sometimes require that homeowners insurance be paid through escrow as well.

Homeowners insurance covers things like fire and wind damage to the home. The annual premium is divided by twelve so that twelve equal payments are made. The lender will then usually make the payment of the premium to the insurance company.

As is the case with property taxes, because mortgage lenders have a collateral interest in the property, they collect and make these payments on behalf of the homeowner to protect the lender, or investor.

What is Private Mortgage Insurance?

You may or may not have a private mortgage insurance (PMI) attached to your monthly mortgage payment. Whether or not you pay PMI was determined when your original loan was taken out when you bought the house. Private mortgage insurance is designed to protect the lender in case the borrower defaults on the loan.

As a general rule, you may be expected to pay PMI if the down payment is less than 20 percent of the home’s value. The PMI is calculated using the homes value, the amount of the down payment and other factors. Usually, once your loan drops below 80 percent of the value of the home, you can typically stop paying PMI, though you should discuss this with your lender.

When a home buyer takes out a mortgage, they may receive a lot of paperwork full of confusing numbers. However, most of the more common features of a monthly mortgage payment are principal, interest, escrow payments and PMI.

Any questions regarding your monthly mortgage should be directed to your lender - most are more than happy to help!

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