People shopping for a first home often compare a quoted mortgage payment against their current rent and conclude the two are close. They are usually not close, because the quoted figure is often only part of what leaves your account each month.
The Four Parts
A typical housing payment has four components, often abbreviated PITI: principal, interest, taxes and insurance. Take a $300,000 loan at 6.50 percent over 30 years, in an area with $4,200 a year in property tax and $1,800 a year in homeowners insurance.
- Principal and interest — $1,896.20 a month. This is the number lenders advertise.
- Property taxes — $350.00 a month, collected by your lender and paid on your behalf.
- Homeowners insurance — $150.00 a month, collected the same way.
- Mortgage insurance — $125.00 a month if your down payment was under 20 percent on a conventional loan.
The real payment is $2,521.20, not $1,896.20. The gap is $625.00 a month — enough to decide whether a house is affordable. Compare the full figure against your rent, never the loan portion alone.
Taxes and Insurance Are Not Fixed Forever
Even with a fixed-rate loan, your total payment can move. Property assessments change, tax rates change, and insurance premiums have risen sharply in many areas. Your lender reviews the escrow account periodically and adjusts what it collects, so a “fixed” payment can still rise. What is fixed is the principal-and-interest portion.
If an escrow analysis finds a shortfall, you will typically be asked to make it up over the following year, on top of the higher ongoing amount. It is worth keeping a little room in the budget for that.
A Note on the Tax Deduction
Older guides describe a home as a tax write-off and say the interest “comes back to you” at tax time. Be careful with that. Mortgage interest is only deductible if you itemize, and since the standard deduction was raised substantially in 2017, the large majority of homeowners do not itemize and get no tax benefit from their mortgage interest at all.
Even for those who do itemize, interest is deductible only on a limited amount of home acquisition debt (currently $750,000 for loans taken out after December 15, 2017), and the deduction for state and local taxes, including property tax, is capped at $10,000. Treat any tax saving as a possible bonus you confirm with a tax professional — never as part of the arithmetic that makes a house affordable.
Paying It Off Faster
Because interest is charged on the outstanding balance, anything that reduces the balance sooner reduces total interest. The best-known version is the biweekly plan: instead of one payment a month, you pay half the amount every two weeks. There are 26 two-week periods in a year, so you make the equivalent of 13 monthly payments instead of 12.
Take a $250,000 loan at 6 percent over 30 years, with a payment of $1,498.88:
- Paying monthly — about $289,595 in total interest over the full 30 years.
- Adding the equivalent of one extra payment a year — about $230,493 in interest, with the loan paid off in about 24.8 years.
- The saving — roughly $59,103, and just over five years off the term.
That is a real saving, but note what produces it: the 13th payment, not the fortnightly rhythm. Three practical cautions follow from that.
- Not every servicer accepts true biweekly payments. Some hold each half payment and apply nothing until the full monthly amount arrives, which removes most of the benefit.
- Third-party biweekly programs often charge a setup fee and a per-payment fee for doing something you can do yourself for nothing.
- You can get the same result by paying one twelfth extra each month, or by making one additional payment a year, and telling the servicer to apply it to principal. Say so explicitly, or it may simply be credited toward next month.
Before paying a mortgage down early, check the obvious comparison: if you are carrying credit card debt at a much higher rate, that debt costs you more per dollar than the mortgage does.