How Is A Mortgage Payment Broken Down? (+ Tips to Reduce It)
With the real estate market in total flux, the house selling rate in 2021 has jumped 44.6% from the previous year.
New homeowners who borrow money to buy their dream houses aren’t just worried about their monthly mortgage payment — each payment also comprises principal payments, interest payments, private mortgage insurance, property taxes, and homeowners insurance.
This is the primary reason why 64% of millennials and 33% of boomers regretted buying a house in 2021, according to a Bankrate poll. And according to the latest statistics by the U.S. Census Bureau, the median monthly mortgage payment in the country is over $1,600.
If you have just become a homeowner and believe that your lender is asking too much for a mortgage payment, you can take things into your hands. Believe it or not, there are many ways to reduce the monthly mortgage payment and save money per month.
So let’s have a look at how is a mortgage payment broken down along with some ways to reduce it.
How Is a Mortgage Payment Broken Down?
Most lenders first calculate the principal and interest payment through a standard formula when estimating a mortgage payment.
A mortgage payment is broken down into four parts:
The primary difference between principal and interest and the monthly payment is that the latter includes extra incurred costs, like property taxes, private mortgage insurance (PMI), and homeowners insurance.
How to Calculate Your Monthly Mortgage Payment
To know how to reduce mortgage payment, you must first go through the following steps to calculate your overall payment:
Step 1: Calculate Your Principal Payment
The principal is the initial loan amount that you intend to borrow.
Suppose you want to buy a $600,000 house with $120,000 cash in hand. You can make a 20% down payment on the house but will need to borrow the remaining $480,000 from the bank.
Thus, the mortgage principal is $480,000.
In the case of a fixed-rate mortgage, you will be required to pay this amount per month for the term. Over time, an increasingly larger percentage of your payment will go toward your principal instead of the interest. Any extra payments will also reduce your principal, leading to fewer interest payments over the term.
Step 2: Determine Your Monthly Interest Rate
Your monthly interest rate is the fee that a bank incurs on the money you want to borrow. You will eventually get a lower interest rate if you have a high credit score, low debt-to-income ratio, and high down payment.
Typically, mortgage companies offer an annual interest rate. To calculate the monthly interest rate, you will have to divide the yearly interest rate by 12.
For example, in the case of a 5% annual interest rate, the monthly interest would be (0.05/12 = 0.0041 or 0.41%).
Step 3: Calculate the Total Payments
This is the time duration (in months) you require to pay off the loan. Simply multiply the years by 12 to get an estimation of the total number of payments.
Thus, in the case of a 15-year mortgage, you will require 180 monthly payments. Similarly, 360 monthly payments will be needed for a 30-year mortgage.
Step 4: Determine the Requirement for Private Mortgage Insurance
The next step is to determine you need private mortgage insurance. Typically, PMI is essential to put down the house price by 20% on the regular mortgage.
Step 5: Evaluate Property Taxes
These are the taxes that a lender collects and saves in a special account, known as escrow. The taxes are then paid to the government at the annual collection period on behalf of the homeowner.
The property taxes are subject to the local tax rates and your home’s worth, which you can easily find on your local government’s website.
Step 6: Find Out the Homeowners Insurance Cost
This is the cost that is mandatory for every homeowner to pay in their monthly mortgage payment.
Step 7: Calculate the Payment
Monthly mortgage payments, without taxes and insurance costs, can be calculated by hand. However, it’s much simpler to use an online mortgage calculator to calculate your monthly payment. For most online calculators, you’ll need to collect some information ahead of time, including:
- Principal payment
- Down payment amount, if any
- Total number of months to repay the loan
- Interest rate
Since property taxes and homeowners insurance are fixed costs, you can add them to the monthly mortgage payment that you will obtain from the calculator. Many calculators will allow you to add these values as well.
How to Reduce Mortgage Payments
If you have been wondering, “how is a mortgage payment broken down?”, let’s jump to the very purpose of why you are here.
Below are some essential tips for how to reduce mortgage payments:
Assess Your Property Taxes
Of course, taxes increase the monthly mortgage payments significantly, but you have to pay them one way or another. Mostly, homeowners rely on their mortgage companies to take care of their taxes. Due to this, they may end up paying more than the actual tax amount.
So, how can you reduce your mortgage payment in this case? Simply assess your taxes on your own at the end of each year. This way, you will be sure of what you are paying as the tax and other requirements.
Adjust Your Mortgage Loan Terms
The simplest way to reduce your mortgage payment is to adjust the loan terms according to your comfort. For instance, if you can’t pay the said amount every month, you can stretch the repayment duration to reduce your monthly payments.
However, the problem here is that you may have to pay more monthly interest on the overall loan.
Moreover, you can also change your loan repayment terms entirely by modifying the mortgage payment on a weekly or bi-weekly basis. This way you can pay less interest.
Find Better Homeowners Insurance Rates
Besides property taxes, the homeowner’s insurance also contributes a lot to your monthly mortgage payment. Again, it’s convenient just to hand the matter to your mortgage company, but you must keep a check on the amount you are paying.
For this, take a tour of your town and see if any other company offers you a better rate.
If you come out unlucky, just ask your mortgage company to reassess the insurance amount you put into the escrow account monthly. This way, you can see any change in the payment on your own.
Refinance Your Mortgage
Refinancing can be applied if you are facing any of these situations:
- More favorable interest rates than at the time of purchase
- Your bank balance improves after the time of purchase
- You want to cash out your home equity
Get Rid of Private Mortgage Insurance
There is no need to pay PMI if you are in debt of less than 80% of the home’s purchase price on your mortgage. So if you are still paying it, cancel it immediately to save around 1% on your home’s purchase price annually.
A sale-leaseback solution may provide you with an easy option to pay off your mortgage in cash.
With a sale-leaseback, you can live in your home as a renter after selling your home. This way, you get the time and money to attend to your other monetary situations while still living in your own home.
How is your mortgage payment being broken down? How can you reduce it? We have some solutions for you to reduce your monthly mortgage payment. If you are still unsure of options to lower your mortgage payment, after reading this article, consult a financial advisor to discuss your options.