The number your lender quotes and the number that leaves your account every month are not the same number. The gap is usually a third of the payment.
PITI, and the two extras it leaves out
The industry shorthand for a mortgage payment is PITI: principal, interest, taxes, insurance. Lenders quote the first two, because that is the part that goes to them. The other two are collected with it and paid on your behalf.
- Principal — the part that reduces what you owe.
- Interest — the cost of borrowing, charged on the balance outstanding.
- Taxes — property tax, usually paid monthly into an escrow account.
- Insurance — homeowners insurance, normally escrowed alongside it.
Then the two the acronym misses: PMI if your deposit was under 20%, and HOA or service charges if the property has them. Neither is small, and both are easy to leave out of a budget until the first statement arrives.
Why nothing seems to happen for years
Interest is charged on what you still owe, so at the beginning of a loan almost all of it is interest. On a thirty-year mortgage it commonly takes about eighteen years before more of your payment goes to principal than to interest.
This feels like a trick and is simply arithmetic — but it has one enormously useful consequence. A unit of principal repaid in year two avoids twenty-eight further years of interest. The same unit repaid in year twenty-five avoids almost none.
Extra payments made early are worth several times the same payments made late.
Escrow: why your payment changes
Your lender estimates a year of property tax and insurance, divides by twelve, and collects it with the mortgage. Once a year they reconcile the estimate against what was actually paid.
If the estimate was low — because your tax assessment rose, or insurance did — your payment goes up, and you may owe a shortfall as well. This is why a payment that was fixed for a year suddenly is not, and it catches almost every first-time buyer. The loan itself did not change; the escrow did.
PMI is temporary, but it is on you
Private mortgage insurance protects the lender against your default. It does nothing for you, and it typically costs between 0.3% and 1.5% of the loan a year.
It normally has to be cancelled once your balance drops to 80% of the home's value. The important detail is that in many cases you must request it — automatic termination often happens later, at a lower threshold. Rising home values can also get you there faster than the amortization schedule suggests, but you will usually need to pay for an appraisal to prove it.
Lenders decide using your debt-to-income ratio, and the usual guidance keeps housing under 28% of gross income and all debt under 36%. But they are underwriting the loan, not your life — they cannot see your childcare costs, your car's age or your appetite for risk. The maximum number you are offered is very rarely the right one.
15-year, 30-year, or something in between
A fifteen-year loan costs dramatically less in total interest and demands a much higher payment. A thirty-year loan is safer and more flexible and costs far more overall.
There is a third option people often miss: take the thirty-year and voluntarily pay it like a fifteen. You capture most of the interest saving, and in a bad month you can drop back to the required payment without renegotiating anything. Flexibility you never use still has value.
Two things that are not in the monthly payment
Closing costs, typically 2–5% of the price, paid up front and out of the same savings as your deposit. And maintenance — a rough rule is 1% of the home's value a year, which is not a bill you receive but is absolutely a cost you pay, usually all at once and at an inconvenient moment.