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What makes up your monthly mortgage payment

Lenders talk about PITI — principal, interest, taxes and insurance. Only the first two repay the loan; the rest is collected into an escrow account and paid on your behalf.

How mortgage interest is actually calculated

Each month, interest is charged on the balance that is still outstanding, not on the original loan amount. The monthly payment is fixed, so as the balance falls, the interest portion falls and the principal portion grows. This is why the first years of a mortgage build so little equity.

The formula lenders use is M = P × r(1+r)^n / ((1+r)^n − 1), where P is the loan amount, r is the monthly interest rate (annual rate ÷ 12) and n is the number of monthly payments.

A concrete example: on a $400,000 loan at 6.5% over 30 years, the payment is about $2,528. In month one, roughly $2,167 of that is interest and only $361 reduces the balance. By year 20 the split has reversed. Over the full term you repay about $510,000 in interest — more than the house cost.

How much house can you actually afford?

Lenders assess two ratios. The front-end ratio is your housing payment divided by gross monthly income; the back-end ratio is all debt payments — housing plus cars, student loans and minimum card payments — divided by gross income.

• 28/36 rule — the conservative benchmark: housing under 28% of gross income, total debt under 36%.
• Conventional loans typically allow a back-end ratio up to 45%, and up to 50% with strong compensating factors.
• FHA loans are more flexible still, often approving up to 50%, but charge mortgage insurance for the life of the loan unless you put 10% down.
• Being *approved* for a payment and being able to *comfortably afford* it are different things. Approval ignores childcare, retirement contributions and maintenance — budget 1% of the home value per year for upkeep.

Private mortgage insurance: when it applies and how to remove it

PMI is required on conventional loans when your down payment is under 20%. It protects the lender, not you, and typically costs 0.3%–1.5% of the loan balance annually — on a $400,000 loan that is $100 to $500 a month for nothing you own.

Under the federal Homeowners Protection Act, your servicer must cancel PMI automatically once the balance reaches 78% of the original value, and must honour a written request at 80% if you are current on payments. If your home has appreciated, you can often request cancellation earlier by paying for an appraisal — frequently a few hundred dollars to save thousands.

15-year versus 30-year: the real trade-off

A 15-year mortgage carries a lower rate and dramatically less total interest, but a much higher required payment. The comparison below uses a $400,000 loan.

Figures are illustrative. The flexible middle path is a 30-year loan with voluntary extra principal payments — you capture much of the interest saving while keeping the option to fall back to the lower required payment if your income changes.

Ways to reduce what you pay

• Shop at least three lenders. Rate quotes on the same borrower profile routinely differ by 0.25%–0.5%, which is tens of thousands of dollars over the term. All credit checks within a 45-day window count as a single inquiry.
• Improve your credit score before applying. The gap between a 660 and a 760 score is often more than half a percentage point.
• Make one extra payment a year. On a 30-year loan this typically removes four to five years from the term.
• Consider paying points only if you are confident you will stay past the break-even, usually five to seven years.
• Recast rather than refinance after a lump sum. Many servicers will re-amortize the loan for a small fee, lowering the payment without new closing costs.