Mortgage Basics

Understanding mortgage payments is essential for anyone considering homeownership or real estate investment. Every monthly mortgage payment is made up of several components, each serving a specific purpose. The three main parts are principal, interest, and escrow.

The principal is the amount you borrow to buy the property. Each payment reduces your outstanding loan balance, gradually increasing your ownership in the home. If you take out a $200,000 mortgage, your principal is $200,000. Suppose your first monthly payment allocates $350 toward principal; after that payment, you owe $199,650.

Interest is what you pay the lender for borrowing money. This amount is calculated based on your outstanding principal and the interest rate on your loan. If your annual interest rate is 6% on a $200,000 loan, your monthly interest for the first payment would be approximately $1,000 :

$\$200,000 \times \frac{0.06} {12} = 1,000$.

The escrow portion of your payment is set aside to cover property taxes, homeowner's insurance, and sometimes other costs like mortgage insurance. The lender collects this money as part of your monthly payment and pays these bills on your behalf when they come due.

To see how these components come together, consider a sample mortgage payment. Suppose you have a $200,000 loan at a 6% annual interest rate and your monthly escrow requirement is $300.

• Your first month's interest: $\$200,000 \times 0.06 \div 12 = 1,000$;
• Suppose your total monthly payment is $\$1,500$;
• Subtracting escrow $\$1,500 - 300 = 1,200$, you have $1,200$ left for principal and interest;
• Of this $\$1,200$, $\$1,000$ goes to interest (as calculated), and $\$200$ goes to principal.

So, your payment is split as follows: $200 toward principal (reducing your loan balance), $1,000 toward interest (the lender’s charge), and $300 into escrow (to pay taxes and insurance later).