October 6, 2023

How do Mortgage Payments Work?

Austin Finch
Mortgage Banker

For those of you who don't own real estate, you probably don't know much about how a monthly mortgage payment is structured. And there's also a good chance that those of you who do own real estate still don't know how your current mortgage payment is structured. So to shed some light, here's a quick and easy run down of your mortgage payment structure.

To buy a house, you'll most likely need to borrow some money. I mean, who has $500k laying around to buy a house in cash? So you go to a bank, and they lend you some cash to help you buy the house. Usually, people like to pay for 20% of the house price with their own money (this is called the down payment) and borrow the other 80% (this is called the mortgage).  Then you arrange a deal with the bank to pay that money back to them over time. Usually, people opt to pay this back over 30 years. The idea being you make a monthly payment to the bank for 30 years, and after 360 total payments (30 years of 12 payments a year), you've paid the bank back, and you then own the home free and clear.

But unfortunately, to calculate your monthly payment, you can't simply divide your total loan amount by 360 and arrive at your monthly payment. Because when the bank lends you money to buy your home, you have to agree to pay the bank interest. In simplest terms, the interest you pay to the bank is a "thank you" fee they require to have done you the favor of lending you money. The total interest you pay is determined by your annual interest rate. The higher the interest rate, the more interest you pay back to the bank over time.

So to determine what you have to pay the bank each month, you must take into consideration 3 factors: the amount of money you borrowed, the length (or term) of your mortgage, and your annual interest rate. Using this, you can determine what your monthly payment to the bank is to not only pay them interest but also to pay down on the total amount that they lent you up front.

Additionally 4 more pieces come into play to calculate your total monthly payment: your property tax bill, your annual home owner's insurance premium, mortgage insurance and HOA dues.  For your annual tax bill and insurance premium, you'll pay 1/12th of those bills to the bank every month, and then the bank pays those bills for you when they come due every year. And if you decide to put down <20% of the purchase price, you usually have to pay the bank monthly mortgage insurance. Lastly, if you own a house that belongs in a homeowners association, you could be required to pay monthly HOA dues.

Below is a calculator for you to calculate what your future mortgage payment might be.

Go Icon