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By Jamie Smith
Mortgage payments are often the biggest portion of a household's monthly budget. But what's included in mortgage payments, and how can you save on yours? To clear up any concerns you may have, we’ll review the most frequently asked questions regarding mortgage payments.
A mortgage payment is simply how you pay off the mortgage loan you used to buy a house. Mortgage payments are typically made every month and are the sum total of four amounts: principal, interest, taxes and insurance. Let's take a closer look at these four factors.
Think of the principal as your actual home loan. You borrowed a certain amount and agreed to pay it back by making a consistent monthly payment. Gradually, the loan balance reduces. If you pay more than the minimum principal amount every month, you can reduce the amount of total monthly payments you make over the course of the loan, which is important for saving money on other costs, like interest.
If you ever wonder why financial institutions lend money, it's because they end up getting slightly more paid back to them. Basically, interest is what the lender charges you for lending you the money. By the time you repay a loan, the additional payment of interest allows the lender to get compensated. Interest is usually calculated differently depending on whether your loan has a fixed-rate or is an adjustable-rate mortgage (ARM).
Real estate taxes are frequently included in monthly mortgage bills. These local taxes fund services that taxpayers need, such as fire and police departments and public schools. These taxes may be due annually, semiannually or quarterly rather than monthly. This infrequent due date can be a budgeting challenge for some homeowners, which is why so many have it included in their monthly mortgage payment.
If your mortgage payment includes your taxes, your lender will set aside a portion of your total payment each month into an escrow account, where the money sits until needed to pay your property taxes. This way, you don’t have to worry about budgeting for and paying (or forgetting to pay) your property taxes. Your lender pays from your escrow account on your behalf from the money you’ve paid them as part of your monthly mortgage payment.
Each mortgage payment will be 1/12th of the entire annual tax bill amount. That amount is reviewed and may be modified each year to ensure that you are paying the correct amount toward your tax liabilities.
Homes are massive purchases for most people, and if something goes wrong, both the buyer and lender want coverage to protect their money. To get a mortgage, you will also be required to have homeowner’s insurance. If your mortgage payment includes your insurance, the lender will factor the insurance cost into your monthly payment, saving that amount in escrow – usually in the same escrow account used for your property taxes – until the insurance payment is due.
Apart from insurance against situations that ruin or reduce a home's value, such as flooding or fire, your mortgage payment may also include a private mortgage insurance (PMI) premium. Homebuyers who get a conventional loan and put down less than 20 percent of the home’s purchase price are usually required to pay PMI. PMI is insurance specifically to protect lenders if the borrower stops paying.. If you want to avoid paying PMI, put 20% down when purchasing the home and give yourself a head start. Alternatively, put down what you can and pay extra until you reach 20% equity. If certain conditions are met, your loan servicer will automatically cancel your PMI when your loan-to-value ratio (or LTV, a measure of equity) reaches 78 percent of the original value of your home.
However, you can call or write a letter asking for it to be canceled when your LTV hits 80 percent, although you may be required to pay for a new appraisal. (These cancellation rules do not apply to the mortgage insurance premium on FHA loans.)
Unlike principal and interest portion of your payment, taxes and insurance aren't due monthly. Taxes are due twice a year, and insurance is usually paid annually. To make things simpler for homeowners, lenders will factor in the cost of these services as part of the monthly mortgage payment. They then take the amount for taxes and insurance out and keep it in a separate account. When insurance or taxes are due, they get paid by the lender through this account, and the homeowner doesn’t have to budget for it or worry about coming up with the payment all at once.
You can pay your mortgage in the same way that you could pay your electricity, internet or phone bill. Although you can still pay by mail or phone, most homeowners prefer to pay online since it is more convenient. It also saves paper and is more expedient than paying by mail. Online payments can also be automated, so you never miss a payment.
Mortgage payments are usually due on the first of each month, with your first payment due at the start of the month after your closing. Although monthly mortgage payments are the most common, your lender may allow you to pay biweekly. Your payment is cut down significantly with a biweekly payment schedule, making budgeting more manageable for homeowners with smaller, more frequent income sources. If you aren't sure which is better for you, use an online mortgage calculator to compare the options side by side.
The longer you hold a debt, the longer the interest accumulates. You should pay as much extra on your mortgage as you reasonably can, for as many months as you can. As long as it's in your means, consistently paying extra could save you thousands over the course of the repayment. Don't be a hero, but contribute what little extra you can afford. Make sure you earmark any additional principal payments to go specifically toward your mortgage principal. Lenders typically have this option online or have a process for earmarking checks for principal payments only. Ask your lender for instructions. If you don’t specify that the extra payments should go toward the mortgage principal, the extra money will go toward your next monthly mortgage payment, which won’t help you achieve your goal of prepaying your mortgage.
Some people hear about prepayment penalties and get concerned about paying extra, so let's be clear. Prepayment penalties – or penalties for paying off a loan too quickly – are only charged by some lenders, and Alliant does not penalize you for prepayments. If your lender does charge such penalties, they may only apply to suddenly paying off the remainder of a loan all at once, such as selling the house or refinancing. But buyer (and borrower) beware! It's wise to read the fine print and check whether a mortgage loan has a prepayment penalty.
If you're only a few days late on your mortgage payment, you may not have to pay any penalties. The majority of lenders provide borrowers a grace period during which they can make a late payment without incurring a fee. Most grace periods are roughly 15 calendar days, but double-check with your lender.
If you know you are going to miss a mortgage payment, you should notify your lender as soon as possible. Communication puts the lender at ease, as it proves you still intend to pay. If you fail to make payments for long enough, late fees and penalties will be charged, and your credit score will be negatively impacted. Being behind on payments for longer, and for greater dollar amounts in total, will hurt your credit score that much more. Eventually, an unpaid mortgage will lead to debt acceleration and eventually foreclosure on the home.
Your lender may be able to provide you with several choices to help you catch up on your mortgage payments. Bottom line – pay on time every month and be proactive if you have to be late.
Ultimately, mortgage payments are quite simple, to the point that many homeowners don't know what is included in one. Once you understand principal, interest, taxes and insurance, you just have to find the right home and mortgage terms for you.
Looking for the perfect home? Alliant has mortgage loan options to fit any budget.
Want to learn more about mortgages? Check out these other articles:
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