How Do Mortgage Payments Work?

Principal

Principal is the amount of money you've borrowed or your outstanding loan balance. You pay a portion of the principal with each mortgage payment.

Interest

Interest is the amount you're charged for borrowing money and is paid directly to your mortgage servicer.

Property taxes

Property taxes are paid to your local government based on your home's assessed value. They may be part of your monthly payment if you have an escrow account, or paid directly to the assessor's office.

Homeowners/hazard insurance

Homeowners insurance protects you against damage to your home caused by fire, theft, wind and/or other covered causes or events. A lender usually requires the insurance coverage amount to equal the property value. If you live in an area that's prone to natural disasters, like earthquakes and floods, you'll need additional policies to cover the risk.
As with property taxes, homeowners insurance is paid either directly to your insurance company or as part of your monthly mortgage payment through an escrow account.

Mortgage insurance

Mortgage insurance (often referred to as MI or PMI) covers lenders against nonpayment or default on a mortgage. It's usually required when the loan amount is larger than 80% of the appraised home value.

The amortization period is the amount of time it will take for you to pay off your mortgage. The longer it takes to pay off a loan, the more interest charged. Your monthly payment's interest portion is based on the scheduled amount that you owe each month.

For a fixed-rate mortgage, the monthly payment stays the same but the portion that goes toward principal increases over time. The payment's interest portion is based on the scheduled amount that you owe each month.

An amortization schedule shows a breakdown of your monthly payment into principal and interest components.

Sample amortization schedule

Loan Amount: $100,000 | Term of the Loan: 30 years | Interest Rate: 6%

Calculation results:

Monthly loan payments: $599.55
Total interest paid over the life of the loan: $115,838.19

For this example, starting with payment number 223 (18 ½ years into the loan), the principal amount is larger than the interest. By the time the last payment is due, the interest is only $2.98 compared to the last principal payment of $596.57.

Setting up your own payment plan

Making extra mortgage payments, above and beyond your minimum monthly payment, is an effective way to pay off your mortgage sooner. Setting up a payment plan gives you the flexibility to make the extra payments when you have the money available. Just keep in mind that you would need to specify with your lender whether you want the extra payments to be applied to your principal, or to future monthly mortgage payments.

Considerations

• If you pay off all or part of your mortgage earlier than agreed, some lenders will require you to pay an early repayment charge.
• Your full payment is due each month. So making extra payments doesn't reduce the amount you pay the next month unless you specify that the payment is for that purpose. Calculate how much could you save with additional payments?