Miranda is an award-winning freelancer who has covered various financial markets and topics since 2006. In addition to writing about personal finance, investing, college planning, student loans, insurance, and other money-related topics, Miranda is an avid podcaster and co-hosts the Money Talks News podcast.
Doug is a Chartered Alternative Investment Analyst who spent more than 20 years as a derivatives market maker and asset manager before “reincarnating” as a financial media professional a decade ago.
Before joining Britannica, Doug spent nearly six years managing content marketing projects for a dozen clients, including The Ticker Tape, TD Ameritrade’s market news and financial education site for retail investors. He has been a CAIA charter holder since 2006, and also held a Series 3 license during his years as a derivatives specialist.
Doug previously served as Regional Director for the Chicago region of PRMIA, the Professional Risk Managers’ International Association, and he also served as editor of Intelligent Risk, PRMIA’s quarterly member newsletter. He holds a BS from the University of Illinois at Urbana-Champaign and an MBA from Illinois Institute of Technology, Stuart School of Business.
A mortgage is a loan used to buy a home. You borrow money from a lender and repay it over a set periodâtypically 15 to 30 yearsâwith interest. The home itself serves as collateral for the loan until itâs paid off.
What factors make up a monthly mortgage payment?
Most mortgage payments include four main parts: principal, interest, property taxes, and homeownerâs insuranceâoften shortened to âPITI.â Some borrowers also pay private mortgage insurance (PMI) if their down payments are below 20%.
What is equity in a home?
Equity is the portion of your home you truly own, based on how much of the mortgage youâve paid off. It grows as you make payments and as your property value increasesâreaching 100% once your loan is fully repaid.
Buying a home is often the biggest financial commitment youâll ever makeâespecially once you factor in the complexities of getting a mortgage.
A home is such a big purchase that youâll likely need to borrow money to close the deal. But how does a mortgage work? And what does it mean to âbuild equity in your homeâ as you pay down your mortgage?
Key Points
Equity represents your ownership in the home versus the mortgage lenderâs stake.
Your equity builds as you pay down the mortgage, and when itâs paid off, your equity stake is 100%.
A mortgage calculator can help you understand how quickly youâll build equity.
Mortgage basics
A mortgage is a loan used to buy your home. You borrow money from a bank or credit union to make your home purchase. The lender allows you to repay your home over a set period, usually 15 to 30 years.
In exchange for the loan, the lender charges interest. Over time, you repay the amount you borrowed plus that interest.
How a down payment affects your mortgage
You can reduce your mortgage payment and the resulting interest charges by borrowing less. Suppose youâre buying a $400,000 home using a 30-year mortgage at 6.5%. Your loan amount would depend on your down payment:
Zero down â $400,000 loan
10% down â $360,000 loan
20% down â $320,000 loan
Amount borrowed
$400,000 (zero down)
$360,000 (10% down)
$320,000 (20% down)
Loan payment
$2,528
$2,275
$2,023
Total repayment
$910,178
$819,160
$728,142
Even if you canât save up a full 20% for a down payment, bringing some money to the transaction can reduce what you pay overall. For most conventional mortgages, a down payment of less than 20% requires you to pay private mortgage insurance (PMI).
Estimate your monthly mortgage payment based on the home price, down payment, loan term, and interest rate.
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Whatâs in a monthly mortgage payment?
Your monthly payment is typically made up of several parts, depending on the arrangement between you and your lender. Here are some items that might make up your monthly mortgage payment.
Interest: The fee the lender charges for using its money. Itâs assessed on the outstanding principal balance.
Property taxes: Property taxes may be included in your monthly mortgage payment. If not, youâll receive a separate bill and must pay it directly.
Homeownerâs insurance: You might make your home insurance payments at the same time as your mortgage. Or you might be responsible for paying your insurance company directly, but your lender might require proof.
Private mortgage insurance (PMI): If you put down less than 20%, you might be subject to PMI, which is essentially an insurance policy that covers your lender in case you default and the homeâs value isnât enough to cover the mortgageâs outstanding principal balance. PMI doesnât reduce your principal, but if youâre required to pay it, your monthly payment will be higher.
Principal and interest represent the actual loan part of your monthly mortgage payment. Property taxes and insurance might be tacked on separately using an escrow account.
Escrow defined
An escrow account is a separate account designed to save up money for homeownerâs insurance premiums and property taxes. Some lenders require it, particularly if you start with a down payment of less than 20%. If youâre participating in an escrow program, your lender will collect this extra amount as part of your monthly loan payment and set it aside to make tax and insurance payments on your behalf.
If you have a fixed-rate mortgage, your principal and interest payments will remain the same throughout your loan term. However, if you have an escrow account, your monthly mortgage payment could change based on rising property taxes, as well as changes to your insurance premiums.
When you have an adjustable-rate mortgage, your payment changes if interest rates rise or fall. On top of that, if youâre paying taxes and insurance through escrow, you could see even bigger swings to your monthly mortgage payment.
Choosing a mortgage type?
For more on fixed versus adjustable-rate mortgages (ARMs), read this overview.
Pay attention to which part of your mortgage payment is principal and interest (P&I), and which part is going to escrow. If you donât have an escrow account, you will pay your homeownerâs insurance premiums and property taxes on your own, so itâs a good idea to save up for these costs.
Hereâs an example of how extra costs can increase your payment, assuming a 30-year fixed-rate mortgage of $360,000 at 6.5%:
Principal and interest: $2,275
Property tax payment (escrow): $263
Homeownerâs insurance (escrow): $66
PMI (escrow): $90
Total monthly payment: $2,694
Your actual payment will vary based on your loan terms and local taxes and insurance costs. A monthly payment calculator can help you estimate your costs.
How does mortgage interest work?
Mortgage interest is the cost of borrowing and accounts for a large share of a home loanâs total cost. Because those payments donât reduce your principal balance, a larger portion of each payment goes toward interest in the early years of the loan.
For example, suppose you get a 30-year fixed-rate loan for $360,000 at 6.5% (with a monthly P&I of $2,275, according to the mortgage calculator) and you make your first P&I payment in February 2027. This table shows how it breaks down over time:
Payment date
Principal
Interest
February 2027 (first)
$325.44
$1,950
January 2042 (15 years in)
$855.91
$1,419.54
January 2057 (last)
$2,263.19
$12.26
Understanding amortization. Mortgages follow an amortization schedule, meaning your payment is fixed so the loan is fully repaid by the end of its term. Because interest is calculated each month on the remaining principal, a larger share of early payments goes toward interest. Over time, more of each payment reduces the principal. So in that first month, that $2,275 is mostly paying interestâyouâre only amortizing about $325.
But the next month, your principal balance would be $359,675 ($360,000 â $325). The next $2,275 payment allocates slightly more to principal, and youâll pay a bit less in interest.
As the loan progresses, the balance declines and the allocation gradually shifts. By the final payment, nearly all of it goes toward principal.
Equity and building ownership in your home
When you have a mortgage, you basically share ownership of your home with the lender. After all, it fronted the money for the purchase. If you donât make payments, it has the right to evict you from your home and take ownership.
Equity is a common mortgage term that refers to how much ownership in your home you can access. Your equity is determined by the appraised value of your home minus the outstanding balance on your mortgage:
You buy a $400,000 home, using a down payment of 20% (or $80,000). Your mortgage is $320,000. The $80,000 you used for a down payment represents your current home equity.
Five years go by, and youâve paid down $20,000 in principal, bringing your balance to $300,000. Meanwhile, the housing market went up and your house now appraises for $500,000.
The bigger your down payment, the larger your chunk of equityâand the faster youâre able to build more equity in your home. As your equity grows, more of each payment goes toward principal rather than interest.
Depending on your lender, your mortgage payment may also include escrow paymentsâmoney set aside to cover your property taxes and homeownerâs insurance (and PMI, if required).
In the early months, your payments are mostly interest. But lenders typically let you make extra principal payments. So if you get a windfall bonus or unexpected tax refund, consider paying down your principal. It works on the same concept as compounding interest, but instead of accelerating the return on your savings, youâre decelerating your interest costs.
