How Are Your Loan Payments Figured?

Introduction

Consumers tend to pay mortgages over long periods of time usually 15 to 30 years because they are such large loans. The Principal balance is reduced gradually by monthly payments slowly at first then rapidly toward the end of the loan. So you ask what costs are actually in a Mortgage payment? When Escrow is used, a monthly mortgage payment is called a PITI payment. The following four costs are covered in each payment:

• Principal: the loan balance
• Interest: Interest owed on that balance
• Real Estate Taxes: taxes assessed by different government agencies to pay for school construction, fire department service, etc.
• Property Insurance: insurance coverage against theft, fire, hurricanes and other disasters

Taxes and insurance are required to be paid out of escrow by most lenders. Lenders want to be protected against Tax liens and uninsured losses that the Borrower can't repay. The Lender will allow the borrower to pay the property taxes and insurance in lump sums when they are due. This does not happen very often. Also, the Monthly Payment might include a separate charge for Mortgage Insurance depending upon the kind of mortgage the borrower has.

Amorization

Mortgages are based on a repayment formula called Amortization because the breakdown of each payment (the amount that goes toward the principal, interest, etc.) changes over time. The lender uses amortization to keep the monthly payments low by spreading the interest you owe on the mortgage over hundreds of payments.

For example, on a 30 year, $150,000 mortgage with a fixed Interest Rate of 7.5 percent, a homeowner who keeps the loan for the full Term will pay $227,575.83 in interest. The lender does not expect that person to pay all that interest in just a couple of years so the interest is spread over the full 30 year term keeping the monthly payment at $1,048.82. During the early years of the loan, the majority of each month's payment should go toward interest to keep the payments stable. For instance in the above example, of the first month's payments only $111.32 goes toward principal. The other $937.50 goes toward interest. Over time the ratio gradually improves, and by the second-to-last payment, $1,035.83 of the borrower's payment will apply to principal while just $12.99 will go toward interest.

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