Understanding what is included in a monthly mortgage payment

Repaying the loan with interest forms the foundation of a new mortgage payment, but other fees can add hundreds of dollars to each month's payment.

Mortgage lenders will add up all the monthly costs of the mortgage when they decide whether you can afford the payment.

So knowing what makes up a monthly mortgage payment can help plan.

What makes up a monthly mortgage payment?

Several key costs work together to build a monthly mortgage payment. These costs include: 

Principal: The amount you borrowed

Principal is the amount of money you borrowed to buy your home. When you borrow $400,000, your principal amount starts at $400,000.

With each monthly payment, the principal balance goes down, but the payment on a fixed-rate loan will not decrease. Instead, the amount of principal and interest included in the payment changes. More on this later, in the section about amortization schedules.

Early in the loan term, the principal balance decreases slowly, with each regular payment. Then the principal reduction picks up speed as the loan ages.

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Interest: The cost of borrowing

Interest is the cost of borrowing, measured as a percentage of the principal balance. An interest rate of 6 percent on a $400,000 loan balance would generate $24,000 a year, or $2,000 a month.

In real life the math is not that simple. The principal decreases with each payment, so you wouldn't owe $24,000 a year, even in the first year. As time passes, the percentage of each payment that goes toward interest decreases. By the end of the loan's 30-year term the interest charges on this loan would be less than $100 a month. As principal decreases, interest decreases.

This, of course, assumes you stay on schedule with the loan. Paying extra on principal each month can lower interest costs dramatically. Falling behind on the payments can increase interest charges.

Property taxes paid via escrow

Most cities and counties assess property taxes which pay for public schools, police and fire protection, public parks, and other public services.

Rather than paying one annual tax bill at the end of the year, homeowners usually pay property taxes throughout the year, in monthly installments added to the mortgage payment.

Let's say you owe $2,400 a year in property taxes. Each month's mortgage payment will put $200 toward this bill. Each month the loan servicer puts this extra $200 into an escrow account. Then, at the end of the year, the full $2,400 is there to pay the tax bill.   

Lenders and loan servicers provide this service because it's an easier way for homeowners to save up the money they need to pay the property tax bill.

Homeowners insurance coverage via escrow

Homeowners insurance could pay to replace or repair your home after fire, vandalism, storm damage, or other perils. Like property taxes, annual homeowners insurance premiums go into an escrow account managed by the lender.

If homeowners insurance costs $1,800 a year, for example, each mortgage loan payment will include an extra $150 that will go toward the insurance bill. Of course, the actual cost of coverage depends on your home, your insurer's rates, the level of coverage you buy, and your location.

Other fees: PMI, HOA, MIP

Along with principal, interest, property tax, and homeowners insurance (known as PITI), a mortgage loan's payment each month could also include:

– Private Mortgage Insurance (PMI) which protects conventional loan lenders from losing money if the borrower defaults on the loan. Most conventional lenders require borrowers to pay PMI when the borrower puts less than 20 percent down on the loan.

PMI costs vary by insurer, loan, and borrower, but it costs, on average, 0.5% to 1% of your loan amount annually. Once again, this big expense gets broken into monthly installments added to each month's loan payment. Borrowers can request to cancel PMI once the loan balance falls below 80 percent of the home's value. 

– Homeowners Association (HOA) fees won't appear in your mortgage payment, but the lender will include this cost in your total housing costs and debt-to-income ratio. HOA dues cover common area maintenance, amenities, and community rule enforcement. Not all homes are located in HOAs.

– Mortgage Insurance Premium (MIP) applies only to FHA loans. This extra fee, charged in place of PMI, varies by down payment size and loan term, but it often adds 0.55 percent of the loan balance each year. This fee becomes part of the FHA loans APR (annual percentage rate), so it won't always appear as a separate line item in a mortgage payment. 

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Amortization schedule changes the formula for each payment

A loan's amortization schedule maps out the entire mortgage journey, from payment 1 to 360 on a 30-year fixed-rate loan. This schedule shows how each payment divides interest and principal.

This payment structure shows why homeowners build equity slowly at first but accelerate over time.

Early payments allocate most of the principal and interest due toward interest, with only a small portion reducing the actual loan balance. This ratio flips as time passes, with later payments going primarily toward principal reduction.

Amortization in action

Let's go back to that hypothetical $400,000 30-year mortgage at 6 percent interest. Your monthly payment stays at $$2,398.20 throughout the loan term, but where this money goes changes dramatically:

The first payment on this loan puts $2,000 toward interest and only $398.20 toward principal. A little over halfway through the 30-year schedule, the interest and principal in each payment cross paths. By the last payment on the loan, only a tiny portion goes toward interest. The rest pays on principal. 

What amortization means for refinancing

By the time a 30-year mortgage borrower gets 15 to 20 years into their loan term, they've already paid well over half the interest that will be charged. They've reached the tipping point where most of the loan's monthly payment goes toward principal.

Refinancing into a new 30-year loan at this point could cost more in long-term interest than it would cost to stick with the first loan, depending on the new loan's interest rate. Refinancing into a shorter term, such as a 12- or 15-year loan, could still save money.

Homeowners should consider the amortization schedule, along with the monthly payment savings, when they refinance.

How to manage your monthly mortgage payments like a pro

Mortgage borrowers can use their loan's amortization and payment breakdowns to save money. 

Here's how:

Review your statement each month

Check your mortgage statement monthly to catch errors before they compound into bigger problems. Focus on these key areas:

• Payment allocation: Verify how your payment divides between principal, interest, taxes, and insurance
• Extra payment application: Confirm any additional payments reduced principal rather than paid on next month's regular payment
• Escrow calculations: Look for unexpected changes in your tax and insurance portions

Loan servicers make occasional mistakes. Catching them early can avoid more expensive surprises later.

Monitor your escrow account

Your escrow account holds funds for property taxes and insurance premiums. It deserves regular attention. Review your annual escrow analysis statement carefully. It shows whether your lender collected too much or too little for these expenses.

Escrow surplus: If your property taxes decreased or insurance premiums dropped, you might receive a refund check from your lender.

Escrow shortage: When taxes increase or insurance costs rise, expect higher monthly payments for the upcoming year, even with a fixed-rate mortgage.

Request escrow account statements quarterly if you expect changes. 

Pay extra toward principal

Additional principal payments accelerate equity building and reduce total interest costs. Even modest extra payments create substantial savings over time.

Consider these strategies:

• Round up monthly payments: Pay $1,850 instead of $1,847 monthly
• Use windfalls: Use tax refunds or bonuses toward principal
• Make 13 payments annually: One extra payment yearly cuts years off your loan term

Extra principal payments decrease your loan balance, effectively shortening your loan term without changing your required monthly payment or requiring a refinance.

Consider bi-weekly payments

Splitting your mortgage payment into two every-other-week installments can save a lot in interest without burdening the monthly budget too much. 

If your payment is $2,400 a month, setting aside $1,200 every other week feels about the same as paying $2,400 a month. But this strategy builds in an extra payment per year since there are 26 two-week periods each year (13 monthly payments). 

Be sure to monitor your mortgage statements to make sure extra money goes toward principal. It's best to check with your loan servicer before adopting one of these strategies.

FAQs about monthly mortgage payments

What are the main components of a monthly mortgage payment?

A typical monthly mortgage payment includes principal, interest, property taxes, and homeowners insurance. Some payments may also include private mortgage insurance (PMI) or Homeowners Association (HOA) fees, depending on the loan and property type.

How does the allocation of principal and interest change over time in mortgage payments?

In the early years of a mortgage, most of each payment goes towards interest. As the loan matures, this gradually shifts, with more of the payment being applied to the principal. This process is outlined in the loan's amortization schedule.

What is an escrow account and why is it important for homeowners?

An escrow account holds funds for property taxes and insurance premiums. It helps homeowners avoid large annual bills by spreading these costs over monthly payments. 

Can making extra payments towards the principal benefit homeowners?

Absolutely. Making additional principal payments can reduce the total interest paid over the life of the loan and help build equity faster. Even small extra payments can make a big difference over time.

When is my first mortgage payment due?

Typically, the first loan payment will be due five to seven weeks after closing. If a home closes on Oct. 10, the first monthly payment is due on Dec. 1.

A preapproval from a lender estimates your real monthly payment

Your monthly mortgage payment is part of your journey to owning your home outright. But before this journey begins, the payment amount also helps lenders approve or deny your loan application.

One of the best ways to estimate your monthly payment size and approval status is to get a mortgage preapproval. A preapproval with Better requires only a soft credit check which shouldn't hurt your credit score. 

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