Think you know how many dollars you'll be sending to your mortgage lender each month? You might not. That's because your monthly mortgage payment is more complicated than you might think. You wouldn’t be the first new homeowner to not understand that a monthly mortgage payment isn't just made up of the money you pay to reduce your loan's principal balance and cover the interest it generates.
Jammie Jelks, manager with Greenbox Loans in Los Angeles, said that homebuyers usually understand that their monthly mortgage payment will include money to pay down their loan's monthly principal balance and cover interest. And these are the two biggest factors that determine how much your monthly loan will cost.
But they aren't the only two, Jelks said. And that's why homeowners often underestimate how much their monthly mortgage payment will cost
It’s all about PITI
Jelks said that homeowners sometimes forget that their monthly payment will usually include the cost of their homeowners' insurance and property taxes, too, Jelks said.
That's where the acronym PITI comes in. It stands for "principal, interest, taxes and insurance," the four main components of most mortgage payments.
You can credit, or blame, the escrow arrangement most lenders require when you take out a mortgage. When you send your mortgage payment each month, your lender deposits a set amount in an escrow account it maintains on your behalf. When your homeowners' insurance and property taxes are due, your lender dips into this fund to pay those bills, again on your behalf.
Because most lenders require this arrangement, most mortgage payments today include extra dollars for insurance and property taxes.
Insurance and taxes matter
Here’s an example. Say your homeowners’ insurance comes out to $1,2000 a year. You’d add $100 to your mortgage payment each month to cover this amount. Now say that your property taxes come out to an estimated $4,800 a year. That’s an additional $400 a month you’ll have to send each month with your mortgage payment
In this example, your mortgage payment would require an extra $500 a month in addition to the money you’re sending to cover interest and principal payments.
Property taxes and homeowners’ insurance can also cause your monthly mortgage payment to fluctuate from year to year, even if you’ve taken out a home loan with a fixed mortgage rate. That’s because the taxes and insurance you pay can change over time. When it does, your lender will adjust the amount of money it needs to cover these bills.
John Espenschied, agency principal with Insurance Brokers Group in St. Louis, said that homeowners' insurance can play a big role in how much your mortgage payment is each month.
Lenders will require that you obtain a homeowners' insurance policy before they approve you for a mortgage. Espenschied says that depending on the cost of the insurance, it could keep buyers from qualifying for their mortgage.
Say your lender has approved you for a loan, but to make the numbers work, your homeowners' insurance policy must come in at about $1,000 a year. If you can only find a policy that costs $2,000 a year, that extra $1,000 could cost you your mortgage, Espenschied said.
That’s why Espenschied recommends that buyers shop around for homeowners’ insurance policies. He also recommends that those who need a lower monthly payment consider taking out a higher deductible, as long as they can afford to cover this deductible should they need to file a claim.
“Insurance can really make a difference,” Espenschied said. “Property taxes, you can’t do much about them. But you can do something about how much your insurance costs.”
Private Mortgage Insurance
Another fee that might add to the cost of your mortgage? Private mortgage insurance, better known as PMI. This type of insurance protects mortgage lenders in case you fail to make your mortgage payments. You must take it out, and pay for it, if you don’t come up with a down payment of at least 20 percent of your home’s purchase price.
PMI typically costs from 0.5 percent to 1 percent of your total loan amount. If your mortgage loan is $200,000, the cost of PMI could be as high as $2,000 a year. That would add about $166 a month to your mortgage payment.
The good news? PMI isn’t a payment that lasts forever. Once you build up equity in your home of at least 22 percent, your mortgage lender is required to drop PMI. You can also request that your lender remove PMI when you’ve built up 20 percent equity in your home. Your lender will probably require an appraisal to determine the current market value of your home once you make this request.
John Bodrozic, founder of El Dorado Hills, California-based digital home management company HomeZada, said that homeowners not understanding the entire cost of their monthly mortgage payment isn't unusual: They also don't understand the total cost of owning a home.
"The mortgage and principal is a big chunk, but property tax, insurance and HOA fees also add up," Bodrozic said. "Beyond that, utility costs and general preventative and repair costs also add up."
If you buy a condo or a home that is run by a homeowners’ association, for instance, you will have to pay a monthly homeowners’ association fee. You’ll pay this fee separately, though, not in your monthly mortgage payment.
Then there is the cost of maintenance. You’ll need to pay money to keep a home running properly, even new construction. How much you spend each year will vary, but that first year after buying a new home? The odds are high that you’ll spend a lot. A report released in 2017 from the National Association of Home Builders found that in the first year after buying a new home, homeowners spend an average of $12,023 on home repairs, new furniture and appliances. Those buying an older home spend an average of $10,922 during the first year after moving in.