How are Monthly Mortgage Payments Calculated

15, August, 2022

As you go through the homebuying process, there are a lot of different factors you need to consider to ensure you’re making the right decision. You want to buy your dream home and afford it comfortably as you consider various mortgage options. When evaluating mortgage options, one of the more confusing aspects is understanding how a monthly mortgage payment is calculated and the components that go into it. There are many different parts to the payment, each of which impacts the figure you pay every month, so it’s crucial to understand each part of the payment. Wondering how monthly mortgage payments are calculated? We’ll explain it to you by examining the different parts of the amount.

7 Components of a Mortgage Payment

1. Principal Balance and Interest

The fundamental parts of the mortgage loan are the principal, i.e., the home purchase price, and the interest. These are the two to pay the most attention to because they make up a significant chunk of the monthly payment. The principal balance of your mortgage refers to the total amount you’re borrowing before interest over the life of the loan, taxes, or other fees. Depending on your loan term, the principal may be higher or lower (e.g., if you opt for a 15-year mortgage, your principal will be higher). Likewise, your mortgage principal and interest will depend on the interest rate you’re getting at the time of the loan and the amount you put down as a down payment.

2. Interest Rate

How monthly mortgage payments are calculated

The interest rate will determine the amount of interest you pay over the life of the loan. This is what the lender charges to provide you with a loan for your home. A part of your monthly mortgage payment will go towards the interest rather than reducing the principal amount, so paying attention to interest rates at the time of borrowing is imperative. You can create an amortization schedule to estimate what percentage of your monthly mortgage payment will go to the interest versus the principal to decide if the mortgage option is right for you.

3. Loan Term

The loan term refers to the number of years you have to pay back the mortgage lender the money you' have borrowed. Your payment calculation will need to include the principal and interest over the period of time your mortgage is for (i.e., 15 years, 30 years) to decide what option is right for you. Bear in mind that a shorter loan term means higher monthly payments, but you pay back the loan faster. Therefore, considering the loan term when looking at the home price and deciding what you can afford every month is essential.

4. Property Tax

Once you've identified the principal and interest you’ll be paying per month, the next step is to add property tax to the mix. However, property tax can often be a bit difficult to estimate as it could change over the life of the loan depending on tax policies. When calculating property tax, estimate for the worst-case scenario to see what your monthly threshold is to afford your payments comfortably. In addition, each state calculates property tax differently, so take time to research how property taxes will affect your payment calculation.

5. Private Mortgage Insurance (PMI)

Another variable cost to consider is private mortgage insurance (PMI). How much you’re paying per month for mortgage insurance will largely depend on the type of loan and your down payment amount. Private mortgage insurance is calculated as a percentage of the total loan amount and can range anywhere from 0.5% to 1.8%, depending on the loan amount versus the down payment. The larger your down payment is, the lower the total loan amount, reducing the amount of PMI you’re paying from your monthly income. When a borrower can put down 20% on a home, PMI is not required. Use the full value of your property to calculate your loan-to-value ratio (LTV) to identify different PMI scenarios based on how much you’re willing to borrow.

6. Home Insurance

Home insurance rates go up and down over the course of the loan, which makes it a bit harder to calculate to determine your fixed payments.

However, just like with the other two variable costs, it’s always better to calculate multiple scenarios, such as best-case and worst-case, to see how your monthly payments are impacted. The policy covers both damage and financial losses from natural disasters, making home insurance a crucial component of protecting your home.

Compare different total premiums and coverage options when calculating your monthly payments to see what kind of protection you’re getting and what you can comfortably afford.

7. Homeowners Association Fees

A homeowners association fee (HOA) is the final component of your monthly mortgage payment to consider. The dues you pay per month will vary, of course, based on the type of home and area you choose. The HOA is a non-profit organization that works to protect and maintain the community. HOAs also come with other rules depending on the community, such as what you can and cannot do to your home, so their involvement is something you’ll want to pay attention to when considering purchasing a home.

The homeowners association fee is something you should be thinking about when looking at homes to buy, and make sure to ask questions about what’s included and what’s expected.  Each HOA operates very differently, so payment schedules could be monthly, quarterly, or even annually. This is another component of the monthly mortgage payment that you should run different scenarios for to understand your obligations and how much you can afford based on all the other components.

Using a Mortgage Calculator to See How Much You Can Afford

Ultimately, using tools like a mortgage calculator is the best way to figure out how monthly mortgage payments are calculated and what you can afford. Based on the components outlined above, you can run scenarios to understand what type of home loan is best for you and what you can afford per month.

This includes identifying interest vs. principal payments over the life of the loan, as well as how PMI, home insurance, and HOA fees will impact the monthly payment. The mortgage option you go for should be based on calculations to ensure that you're entering a loan that you can afford alongside other monthly expenses, and maintain financial security over time, including a comfortable debt-to-income ratio.

Use our mortgage calculator to understand how much you could potentially pay in mortgage payments while budgeting for a better financial future.