Nuts and Bolts of the Monthly Mortgage Payment

Your mortgage payment consists of PITI - Principle, Interest, Taxes, Insurance. You'll also have to add in your PMI if you have it or your 2nd trust if you have one.

Other monthly expenses which are not included in the mortgage but which should be factored into your budget are HOA/Condo dues and estimated utilities.

Insurance and Taxes

Now, let's go back to PITI. I want to talk about the taxes and insurance first. When you first get your mortgage, the lender has a vested interest in what happens to the house - if you foreclose, etc. - the lender is stuck with your house. For that reason, they don't want to take any chances that the home owner won't pay their taxes and home owner's insurance. So, they divide the yearly amount due by 12 and wrap it into your required monthly mortgage payment. On their side, they hold this money in an escrow account and pay the insurance company and county directly when the insurance and taxes are due. You probably won't receive a bill for either of these things, but if you do, you should let your lender know b/c they have probably already paid it.

Interest and Interest Only Loans

Now, about interest. This is really simple to calculate b/c it's simple interest (he he). You take the principle amount of the loan, multiply by the interest rate (which gives you the yearly amount of interest), and divide by 12 to get the monthly amount.

So, let's say you buy a house for $400,000. You have a 5% downpayment - that's $20,000. And you have a 95% 1st trust - that's a principle of $380,000. The interest rate is 6.5%. So, the interest due in the first month will be $380,000*.065/12 = $2,058.

(Note, for this example, you would also have a PMI or Primary Mortgage Insurance factored into your mortgage - see previous post).

If you have an interest only loan, your mortgage payment will not include any payment toward your principle. But, as with any loan, you have the option to make additional principle payments in any amount at any time. When you do make the principle payments, the amount of your next interest only mortgage payment will be reduced because it will be based on the new, reduced principle amount.

Principle and Amortized Loans

If you have an amortized loan, your mortgage payment will include a principle payment and the sum of principle and interest will be exactly the same each month. The interest portion is still calculated the same way - simple interest. So, what ends up happening is that you pay a lot more interest in the beginning and at some point, you start paying more principle per month than interest.

What happens if you make extra principle payments when you have an amortized loan? It does not reduce the amount of the monthly payment that is due, but it does reduce the life of your loan. So, for example, if you had a 30 year fixed amortized loan, and you consistently made extra principle payment, you may pay off all the principle in 20 years instead of 30 years.

There is a complicated amortization formula that is used to determine the monthly payment that would be required in order to pay off the principle by the end of the loan period. See the link to the wikipedia page for the formula. If you like excel, use the PMT function. And there's a lot of scientific and financial calculators that can do this as well.

I will be happy to provide you with an amortization table for your specific situation if you would like - just say the word.

Here is the link to the wikipedia page on amortization - http://en.wikipedia.org/wiki/Amortization_(business)