When you become a homeowner, it’s likely you’ll have to pay for a monthly mortgage – but do you know exactly what you’re paying for?
It’s important that you understand your outstanding balance as well as interest rate that you currently owe. A mortgage payment has four parts: principal, interest, taxes, and insurance. Here’s a quick rundown of each!
Essentially, the principal is the repayment of your loan amount. This is the portion of the payment that is used to reduce the balance you owe – your principal repayment will be the same throughout the life of your loan if you chose a fixed interest rate option. Usually, lenders will want to earn their interest back first before reducing principal – so payments will mostly go towards the interest of the loan in the beginning.
Interest is the profit that goes to the lender. This rate is expressed as a percentage of your total loan balance, and these rates are constantly changing. It’s best to choose a mortgage with a fixed interest rate, if you want a number locked in. A 5% mortgage rate means you will pay 5% of your total loan balance in interest each year. If you took a fixed rate, this percentage will never change during the life of your loan.
While this is the area that might be the most overlooked on a loan, it’s one of the more important figures in your payment plan. Most lenders will require you to include an escrow account that will take care of your property taxes – if you have an escrow, your lender usually saves up those monthly payments into this separate account. At the end of the year, the escrow company will take the money from your account and pay your property taxes.
Insurance usually falls within escrow as well. Lenders do this to ensure that you are always covered in the event of an emergency.
Don’t forget to shop around for your mortgage! We wrote about shopping for a mortgage here – check it out!