The Components of a Mortgage Payment: Principal, Interest, Taxes, Insurance
There are two main components of a mortgage: principal and interest. The optional components are taxes and insurance.
This amount is what you actually borrow from the lender. For example, if your mortgage is $100,000, the principal is the same exact amount. The principal is one of the main components of a loan payment consists of.
Even though you have monthly, fixed installments, portions of the amount you pay changes.
Since the money is not technically yours, you have to pay extra in return; this is the interest. Interest rates a range from 2-3% to over 10%. The higher your interest, the more you pay monthly. As a result, the overall cost of your loan increases too.
No one can avoid taxes. If you own property, you have to pay taxes on it. The taxes you pay depend on many factors such as the type of property, location, city, country, etc. Every country has their own way of how they manage and collect taxes.
Inuring your property gives you an assurance that your home is safe from any form of damage on the property. Property insurance and private mortgage insurance are two types of coverage. PMI covers various damages to your home such as fires, natural disasters, thefts, etc.
Even though property insurance isn’t mandatory, banks want people to include it with their monthly payments.
How to Calculate a Mortgage Interest
As stated before, the amount you pay month-to-month doesn’t change. Also, keep in mind the portions that compromise the amount you pay changes over time. One rule of thumb is that the amount of interest is higher than the amount of principal you pay.
The amount of interest you pay changes due to the fact that what you owe changes too. That’s why the interest payment decreases every month down to the last payment. This is why you need the current balance to calculate the interest.
Here’s the formula: current principal X annual interest rate / 12 (months)
Compute the Interest in 5 Steps:
Step 1: You need to check your current loan balance. Your mortgage statement you receive monthly shows this information.
Step 2: As the formula states, you now need to multiply the annual interest rate by the current loan balance. Your statement includes the rate as well. If you have a $100,000 loan with a 5% interest rate, the amount you get is $5,000.
Step 3: Now divide the annual interest by 12. In this scenario, $5,000/12 is $416. The amount you see is the amount you pay in interest each month.
Step 4: See how much your overall monthly payment is and then subtract from the amount of interest, which is $416 in this case. It’s necessary to do this because it’s important to know the amount of principal you owe after each payment.
Let’s say that your monthly payment is $650. If you subtract $416 from $650, you get $234. $234 is the amount that goes towards the principal.
Step 5: Since you now know the amount of interest and principal you pay, let’s check the balance. Previously (in step 2), we said that the principal of the loan is $100,000. The next thing to do is subtract $234 (the principal payment) from $100,000 (principal).
The result you get is $99,766. This is the amount of money on what the interest will be estimated for the next month.