Homebuyers

What's Really in Your Monthly Mortgage Payment? Breaking Down the Costs

You're eyeing what could be the ideal home for you and your family, but the monthly payment estimate has you a little confused. You may be used to paying rent, but a mortgage payment has a few more parts to it than a rent payment.

Don't worry, you're not alone in feeling overwhelmed. However, understanding exactly what makes up your mortgage payment can give you peace of mind. Once you break it down, you'll see the advantages that come with owning a home—like building equity—things renting just can't offer.

There are a number of financial pieces to the mortgage payment puzzle. Let’s take a look at each one of them and see how it all comes together.

Principal and interest: the heart of your payment

When you make a mortgage payment, you're paying off two main things: the principal (the amount of money you borrowed) and the interest (what you pay to the lender for the privilege of borrowing that money).

The principal is gradually paid off over the life of the loan, while the interest goes to the lender. In a nutshell, principal and interest form the core of your monthly mortgage payment.

However, unlike rent, your monthly mortgage payments are going toward homeownership. Over time, as you pay down the principal, you build equity in your home.

Escrow: “set-it-and-forget-it” convenience

One of the most comforting features of homeownership is escrow. If you're financing your home, your lender may offer to manage your property taxes and homeowners insurance as part of your mortgage payment.

It's a convenient approach where part of your monthly payment goes into an escrow account. When the bills for taxes and insurance come due, your lender takes care of them with the money from that account.

"I always like to have everything included in my payment just because it's a 'set it and forget it' process," says Hamest Manoukian, a loan officer for New American Funding based in Whittier, Calif. "You make the payment, and you don't have to worry about it."

This is a huge benefit compared to managing separate payments each year, as taxes and insurance can add up to a hefty lump sum. It's especially helpful for anyone who doesn't want to scramble for a big payment once or twice a year.

Mortgage insurance: protection for the lender, a cost for you

Private Mortgage Insurance (PMI) is typically required if your down payment is less than 20% on a Conventional loan. This insurance protects the lender in case you default on the loan, but it can be a significant portion of what you pay each month.

The cost of PMI varies based on factors like your credit score, loan-to-value ratio, and the size of your loan. The good news? PMI can often be removed once you reach 20% equity in your home.

FHA loans require Mortgage Insurance Premiums (MIP), which are usually paid for the life of the loan unless you refinance into a Conventional mortgage or put at least 10% down, in which case MIP lasts for 11 years.

Mortgage insurance is one of the costs of making homeownership more accessible for borrowers with smaller down payments or less-than-perfect credit. While it can feel like an added cost, it’s an investment that helps many achieve the dream of homeownership sooner.

Homeowners Association (HOA) fees: a separate cost to consider

If your new home is part of a community governed by a Homeowners Association (HOA), there may be additional monthly, quarterly, or annual fees. These fees are generally separate from your mortgage payment, though you'll want to factor them into your total housing costs.

While the HOA helps maintain the community and common areas, these fees won't show up in your mortgage statement, they come from the HOA directly.

"It's not going to be included in the mortgage statement," said Manoukian. "They get a separate bill directly from the HOA."

What are the average monthly mortgage payments?

In 2023, the average monthly payment for a conventional 30-year fixed-rate mortgage climbed from $2,045 to $2,295, a 12.2% increase, according to a report by the Consumer Financial Protection Bureau.

An increase in interest rates is the main factor causing payments to climb.

Over the past few years, mortgage rates have risen more than five percentage points since hitting a historic low of 2.65% in January 2021. In October 2023, rates peaked at 7.79%, and even now, they remain above 6%, according to the report.

When you combine these higher rates with rising home prices, affordability has become a challenge for many. However, as rates ease and home prices adjust, millions of borrowers may be able to refinance and lower their monthly payments—allowing for more affordable homeownership in the future.

The long-term benefits of homeownership

While current interest rates and home prices can create some initial shock, the long-term benefits of homeownership far outweigh the drawbacks.

Over time, as you pay down the mortgage and your home potentially increases in value, you build wealth. As home prices rise and rents continue to climb, owning a home becomes a powerful tool for securing your financial future.

Hamest Manoukian NMLS # 485360