Mortgage Payment: The 3 Parts Explained - YouTube

Hey this is Jeremy from Shine Insurance and today we're going to dig into the

three parts of your monthly mortgage payment.

That's right, when you make your monthly port mortgage payment it is actually

paying for three different things with your mortgage company.

I'm going to dig into what those three things are right now. So the first

thing is what you would think that you're paying for and that's called

principal.

The next thing is interest. Finally,

one of the more confusing part is the escrow account contribution.

I'm going to shed light on all three of those things right now. So let's start

with principal. Principal is a part of your monthly payment that goes towards

paying down your debt. So you borrowed money from the bank and of course you

have to pay that money back. That makes total sense.

So each month one part of what you're paying back to the bank is

actually paying down the debt that you owe. So that makes sense right?

Let's dig into interest. Interest is the part of your monthly payment that goes

towards paying the mortgage company for the privilege of borrowing their money.

Now, we wouldn't expect a business to loan us a bunch of money (often

hundreds of thousands of dollars) and not want something in return.

Of course they do want something in return. Interest is what they get

in return.

So it's extra money that you're paying on top of what you borrowed back to the people

that you borrowed it from. An important side note here. There are two main different kinds of mortgages

that you can purchase. There's the fixed

rate mortgage and there's adjustable rate mortgages. The best mortgages

are the fixed rate mortgage which means the interest rate won't change over the

course of the loan. So you know what you're getting, you know what is going to

cost for the total course of the loan. If it's a 30 year loan and you have a

four percent interest rate then you know with a fixed rate mortgage, that can't change.

So that's the best kind of mortgage. The other kind is called adjustable rate. Unless you're

a financial guru really try to avoid these adjustable rate mortgages. This is

because they can change in ways that you just don't understand.

So five years down the road you could be paying a totally different

monthly amount for your mortgage and you could be paying a lot more

interest to the the mortgage company than you thought you would be because the interest rate

was adjustable. So if you're a financial guru and you look at

a loan you want to get, it has an adjustable rate and you really

understand exactly how the whole thing is set up... great but

for the rest of us, we want to stick with fixed rate mortgages because they're

just easier to understand and they're more stable.

The third part is the escrow account contribution. This is

simply the part of your monthly payment that goes towards paying your property

taxes and your homeowners insurance. So these are actually bills that are paid by

your mortgage company out of an escrow account that you're contributing towards

every month. You're paying a little bit in each month

and then the bills for property taxes or the bills for homeowners insurance go to

your mortgage company and the mortgage company pays that. But of course they're

not going to pay out of their own pocket. That wouldn't make sense.

They're paying it out of your escrow account which is a little tiny bank account that's

connected with your mortgage. If you have a fixed rate mortgage than insurance and

taxes are really the only reasons that your monthly mortgage payment amount

should ever change. So another really good reason to have a fixed rate mortgage is

if something changes about your monthly payment, you get a bill in the mail from

your mortgage company and it says well you were paying 900 bucks last month

now we need you to pay a thousand dollars, you say wait a minute why?? If you have a

fixed rate you know you can zoom right in on insurance or taxes to figure it out

Ok let's put this into a visual picture that we can follow through the rest of

this video. So let's use the example of a nine hundred dollar monthly payment.

In this example we could say that principal, interest, and escrow are broken

up into $300 a month for principal, $400 a

month for interest, and $200 a month for escrow. That

would be perfectly reasonable and will dig into why

in a second but I want to zoom in first. I want to push the escrow thing

over to the side for a minute and just kind of put that on hold.

Let's look at interest and principal. So let's look at what you're paying back

the money borrowed (Princple)and you're paying back as well as the extra money you're

paying to the mortgage company for the right the privilege of borrowing money

from them (Interest). At the very beginning your monthly payment is going to have a lot

of interest in it and the principal your payingmight be a very small amount

to start. So you're really not paying back a bunch of money that you borrowed.

You're paying a ton of interest. A lot of people say the mortgage

company is setting you up or trying to make things harder for you.

There's lots of different opinions on why it's set up this way

but let me just show you exactly what's happening here and why you're

paying more interest than principal at the beginning of your loan.

So let's use the example of a $150,000 loan with a

4% fixed interest rate. We're gonna make all these numbers really

really even. So I have it broken down here into year 1, year 10, year

20, year 30. This shows what you owe at those given periods of times and what

four percent interest would be on that for a whole year. So let's just look at

year 1. On year 1 we we have $150,000 of course because

we just borrowed that money. 4% of $150,000

is $6000. So over the course of this first year you're going

to need to pay back $6000 in interest. So what we do is we

break down the monthly payment and we say okay,

the monthly payment is $900 and that's what set at the

beginning of the loan. I kind of want you again to push the escrow part out of this picture.

I didn't want to remove it from the picture because it is the third part of

your payment but for right now we're focusing on principle and interest.

As you can see principal and interest will add up to$700.

here. In fact, all the way through my example they're going to add up to $700

So in this first year, let me go back and remind us, we're paying $6000

in interest. If we divide that by 12

we know that we're going to be paying $500

a month. So we're paying $700 a month no matter

what every month for principal and interest through the course of the loan.

If interest is going to cost us $500

there's only $200 left pay towards principle.

So at the beginning of our loan we have a lot of interest to pay because we

still owe a lot of money, There's not a lot left for the principal to be

paid if we're going to stick with that $700 for principal and interest.

So $500 for interest leaves us

$200 for principal. Now we jumped to year 10 and we've paid down about $30,000

So what we owe in year 10 is $120,000. Now we do

some basic math here.

4% of $120,000 is going to be

$4800. So on year 10

we're going to have to pay $4800 in interest. If we divide

that into 12 equal months were going to be

paying$400 per month right?

So we have to pay $400 per month in interest and we know

that between interest in principle we can only pay $700 because that's

not going to change.

So $300 is what we're paying for principal. Interest is figured

first. Principle is what's left over. So we had $400

dollars in interest now we're paying $300 in principle. Ok so

on year 20 you owe $80,000. 4% of that is $3200

$3200 means that for this given time we are paying about

$300 in interest. Now it's really gonna be $3600 that we're paying so I'm

off a little bit here on the number but just to keep it even

let's stick with this idea that we're paying about $300 in interest.

We know that the two broken up between principal and interest need to be $700

We're paying $300 in interest. That leaves about $400 for

principal. So that's what will be paid in principle. Notice now we're

paying a lot more in principle. We've broken over that X and now we're paying

more in principle less in interest. This also means we're starting to pay down our loan

more quickly.

Finally year 30

we've got $12,000 left. That means 4% of that is gonna

be $480. We break that by the month

that's just going to be $40 bucks per month in interest.

Obviously now the lion's share of that $700 is going towards the principal.

We're paying down the principal much faster and that is because we're

not paying as much interest. So over the course of a loan

we start with more interest because we owe more money and we're not going to

change the amount of money we're paying for a monthly payment. That

doesn't leave very much space for paying principle. But as we move along in the

loan there's less and less interest that needs to be paid in that $700.

This leaves more space for the principal and therefore we start paying

principal more which means we start paying the loan off more quickly. So

principal is the amount of money we're paying off that we borrowed. Interest is

the amount of money that the bank is charging us for the privilege of

borrowing money from them. Those two things kind of cross over the course of

the loan paying more principle and less interest as we go.

But there's a rookie mistake that lots of people make and I made

it on my first loan.

I had no idea what my escrow account contribution was and so a year or two

into my loan my monthly payment went way up. I thought the mortgage

person had duked me you know had set me up or something like that. I

was just wrong though because i didn't understand my escrow accounts impact on

my monthly payments.

So you're going to understand better than I did in the next two minutes. You're going to understand

exactly how your escrow account works. So your escrow account, as we've said

before, is for the sole purpose of accumulating money in a little tiny

bank account that is going to pay for your property taxes and is going

to pay for your homeowners insurance.

The reason the mortgage company wants control over this money is they want to

know that these bills are being paid. if you don't pay your property taxes the county or the city can come in

and put a lien on your house or all kinds of nasty stuff.

If you don't pay your homeowners insurance and your house burns down then

you still owe a bunch of money and your insurance company can't pay to

rebuild your house and so there isn't any asset there for the to get

that money back.

So they want to know that those two things are being taken care of.

By including an escrow account in your mortgage loan they know it's

being taken care of because they're the ones making the payments.

ok so how does an escrow account work. Well let's just look at it month by month.

Month one in this example we're putting $200

into our escrow account and so we've accumulated $200 total in our

escrow account.

Month Two we put 200 more - 400 altogether. MonthThree $200 in $600 total. Month Four we add

another $200. Now we're all the way up to a big old $800. Month 5

$200 in - $1000 total. Month 6 $200 in - $1200 total. Then a homeowner's payment

comes in. A bill for homeowners insurance and they want $100 for the

homeowners insurance. Now that bill remember doesn't go to you, it goes to

your mortgage company and your mortgage company is going to pay that out of what

you've accumulated in your escrow account. So your mortgage

company's going to pay that $1000. That

means that what's going to be left in your escrow account is $200.

So it just continues on like that. So Month 7 you pay $200

in that accumulates to four hundred dollars and so on and so forth.

You're paying a certain amount of money into your escrow account every month

that escrow account is accumulating and then when the bill comes in the escrow

account is going to pay that bill and it's going to be taking care of.

Everything is hunky-dory.

Now here's where you can get in trouble. What if your insurance becomes $1700?

What if your mortgage company gets a $1700

bill for homeowners insurance because insurance premiums can change, right and

they certainly do change.

In that case your mortgage company figured that

it was going to be $1000 for insurance but then it became $1700

the next year.

What's going to happen to your escrow account? Well that escrow account is

going to get overdrawn because that $1700 got paid out

and now you're negative 500. So look at what the mortgage company does.

In those cases they say, "oops, we're not collecting enough money the bill is

higher than what we thought it was going to be so we're not collecting enough

money." What are they going to do? It may not happen right the next

month but

they're going to charge more money for your escrow portion of of your mortgage

payment. So here we've got it up to $300 and now start to accumulate your escrow account back up.

So what does that do to your monthly payment now that they

raised the escrow contribution $300? What's going to happen your

monthly mortgage payment? Well of course the principally interest

can't change and so we see in this example we still have $700

that we're paying to principal and interest. So those aren't going to change at

all. But escrow now went up from $200 to $300 What's going to happen is that

your total monthly payment is going to go up from $900 to $1000. So

your escrow contribution went up by $100 and therefore you're

total monthly payment went up by $100. They are directly related to

each other. That's where people get confused a lot. So that was it. OK let's

review the three different parts of your monthly mortgage payment.

We start with principal. Principal is the part of your monthly mortgage

payment that you think you would be paying which is going towards the debt

that you borrowed. Paying down the money you borrowed. Y,ou borrowed money you're

paying it back.

Interest is the amount of money that we pay to the mortgage company

for the privilege of borrowing their money. They're not gonna loan us money

for free. Interest is how they make money off of loaning us money. Fiinally your

escrow account. This is the part of your monthly payment that goes towards paying

your property taxes and homeowners insurance.

It can grow (from your taxes or insurance going up). When the escrow portion goes up

that's going to cause your monthly payment to increase.

All right, you got it! That wasn't so hard, right? Three parts of your

monthly mortgage payment > now you know.

If you want some other Shine videos we've got some great ones for you.

Starting off with a New Home Buyers Guide. This really walks you through from

beginning to end from thingking "hey maybe I want to buy a

house" and all the way through to the very end. There's a little part of

it that's very much about the same thing as this video here,

what your monthly mortgage payment is. But also talks about all the things that happen in the

escrow period (which is completely different than an escrow account

interestingly) and loans and all those kinds of things. A new home buyers guide

laid out really nicely for you. Real simple.

We've got five steps to a homeowners claim, something you should know whether

you're involved in a claim or not.

So you just understand how homeowners insurance claims work and

then finally, if you just want to laugh,

how not to light a bonfire. This is part of our #noinsurance4u series and

it's a video of someone making some pretty poor decisions that combine

gasoline and a bonfire. You can check that out over on our youtube channel.

ok what's next? - as always the last step in this video is really really simple.

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Awesome, i hope you enjoyed this video. I know I enjoyed creating it for you and

I'm glad that you understand your mortgage payment in a way that you

didn't before.

So until the next time have a wonderful day!