How Are Mortgage Payments Calculated?

Mortgage payments are payments made for the purchase of a home. Typically, potential homeowners go to a bank or mortgage company to obtain a mortgage, but sometimes a private individual will hold the mortgage (called owner financing). The mortgage payment consists of principal payment, which is the amount the customer needs to buy the home, interest, taxes and insurance. Banks refer to these factors as PITI (principal, interest, tax, insurance). PITI, plus the term, which is the length of time to pay the mortgage, determine how mortgage payments are calculated.

Term

Term means the amount of time for which the bank will finance the home. The usual term for a mortgage is 30 years, but this can vary. Many people want to pay off the mortgage faster and may take a 15- or 20-year term. Longer terms mean smaller payments for the customer.

Principal

When you buy a home, most lending institutions require a down payment. This may be as low as 3 percent of the full amount, although the industry standard calls for 20 percent. The price of the home minus the down payment equals the principal. For example, if the home costs $100,000, and the homeowner pays $20,000 down, the bank finances a principal of $80,000.

Interest

Interest is the amount banks charge for taking the risk of making the loan. Interest rates vary depending on many conditions, including the customer's credit worthiness. Customers with excellent credit receive the best interest rate since the risk factor for the bank diminishes. Lower interest rates make mortgage payments lower.

Taxes

Most banks insist that they include property taxes with the mortgage to ensure the taxes are paid. The local taxing authority determines the tax due and reports the information to the mortgage company. The mortgage company factors in the tax on a monthly basis and adds this to the payment.

Insurance

Banks require insurance on the home in the event of fires and other hazards. If a catastrophe happens, the insurance company pays off the loan to the bank. The bank obtains the insurance policy and factors this into the monthly payment. If a customer puts less than 20 percent down to buy the home, the bank requires the customer to buy another insurance policy called private mortgage insurance (PMI). PMI pays the bank the balance of the difference between actual down payment and 20 percent in case of default by the customer. The bank obtains this policy and adds the cost to the payment

How it adds up

The bank enters these factors into a calculator (see Resources below) to calculate the mortgage payment for the particular customer. For example, using the principal of $80,000 with a 6 percent interest rate, for a term of 30 years, yearly tax of $1,000 and annual insurance of $300, the monthly payment comes to $587.97 per month for 360 months or 30 years. Using the same figures but changing the term to 15 years or 180 months makes the monthly payment to $783.41.

Resources

• Calculate mortgage payments