How Does a Mortgage Payment Work?

Taking out a mortgage helps you purchase a home without paying the entire cost up front. Paying off the mortgage over time enables you to become a homeowner.

Because mortgages can be complex, you might be wondering how the payments work. Understanding what is included in a mortgage payment can help you feel more confident in your homebuying decisions.

The following are the main components of a mortgage payment.

1. Principal

The principal is the amount borrowed from your mortgage lender that you must pay back. This amount typically is the home price minus your down payment. For instance, if you purchased a $200,000 home and put down a 20% down payment of $40,000, your principal would be $160,000 ($200,000 - $40,000 = $160,000).

Most of your monthly mortgage payment goes to paying down the principal and interest. The part that goes toward your principal pays down your mortgage and builds your home equity. Most mortgages pay down more interest at the start of the loan and more principal at the end.

2. Interest

The mortgage lender charges interest on your principal for taking the risk of loaning the money. Your interest rate depends on the following factors:

• Credit score

• Debt-to-income ratio

• Down payment amount

• Loan type

• Loan term

• Property location

• Inflation

• Federal Reserve policy

Your mortgage payments will initially include a higher proportion of interest, which will be significantly lower near the end of your mortgage.

3. Taxes

Your monthly mortgage payment might include real estate taxes, also known as property taxes. Local governments assess these taxes to fund schools, fire and police departments, public works departments that maintain municipal infrastructure, and other public services.

Although real estate taxes must be paid annually, most homeowners pay them in monthly installments as part of their mortgage payments. The lender holds the taxes in escrow, then pays them on the homeowner’s behalf when due.

If you notice your taxes don’t align with your home price and tax rate, it likely is because most counties base property taxes on the home’s assessed value rather than the purchase price. A property assessor evaluates your home and shares its value with the government, which can impact your property taxes.

4. Insurance

Many types of insurance might be included in your monthly mortgage payment:

• Property insurance: Covers your home in case of a burglary, fire, tornado, hurricane, or another disaster.

• Homeowners insurance: Covers your home and personal possessions if they are damaged by theft, fire, wind, earthquake, or another disaster.

• Private mortgage insurance: Protects the lender if your down payment was less than 20% and you stop paying your mortgage. You can request to remove the PMI when you have 20% equity, meaning you own 20% of your home. You can determine your home equity by subtracting the amount owed on your mortgage from the current market value of your home.

Similar to property tax payments, insurance payments are due annually. Most lenders collect insurance payments with mortgage payments, hold the funds in escrow, and pay the insurance on behalf of the homeowner when due.

5. Other Homeowner Fees

Miscellaneous fees, such as loan processing fees, might be included in your mortgage payment. These fees typically are a minimal percentage of the payment.

6.     Homeowners Association Fees

If you belong to a Homeowners Association (HOA), your mortgage payment might include HOA fees. Minimizing the number of monthly payments provides convenience. 

*This information is for educational purposes only.