Mortgage Basics: Payments, Interest and Smart Choices

How the monthly payment is built

The headline number, principal and interest, comes from the same amortization formula as any loan. On a $300,000 loan at 6.5% for 30 years, it is about $1,896 a month.

But the real check is PITI: principal, interest, taxes and insurance. Property tax and homeowner's insurance are often escrowed, adding hundreds more. Always budget PITI, not just P&I.

Lenders use the 28/36 rule: housing costs under 28% of gross monthly income, total debts under 36%. It is a ceiling, not a target; comfortable is usually lower.

Amortization: the slow start

In year one of that $300,000 mortgage, about $19,300 of your $22,750 in payments is interest. You build barely $3,400 of equity from payments in the first year.

This is normal, not a rip-off: interest is charged on the balance, and the balance starts huge. It is also why selling in the first few years builds little equity beyond price appreciation.

Extra principal payments early are disproportionately powerful. $200 extra a month from the start can shave years off and save tens of thousands.

Down payment, PMI and points

Putting 20% down avoids PMI, private mortgage insurance that protects the lender, not you. PMI typically costs 0.5% to 1% of the loan yearly until you reach 20% equity.

Points are prepaid interest: one point costs 1% of the loan and lowers the rate. Buying points pays off only if you keep the loan past the breakeven point, usually 5 to 8 years.

A bigger down payment also means borrowing less, which cuts both the payment and total interest. It is the simplest way to make a mortgage cheaper.

Fixed vs adjustable rates

Fixed-rate mortgages never change: predictable for 30 years. Adjustable-rate mortgages (ARMs) start lower, then adjust with the market after the fixed period.

ARMs make sense if you will sell or refinance before adjustment, or if you can absorb higher payments. Otherwise the initial savings rarely justify the risk.

When comparing, look at the fully indexed rate and the caps, not just the teaser rate.

Refinancing: when it pays

Refinance when the rate drop is big enough that monthly savings repay closing costs quickly, usually within 2 to 3 years. A common trigger is a 0.75 to 1 point improvement.

Watch the term reset trap: refinancing a 30-year loan 10 years in with a new 30-year loan restarts the clock. Consider a shorter term to actually save.

Also consider cash-out refinancing carefully: it converts equity back into debt, which is fine for value-adding renovations and dangerous for consumption.

The true cost of the house

Add it all up: 30 years of payments on $300,000 at 6.5% totals about $682,600, meaning $382,600 of interest. The house costs more than double its price.

This is not an argument against buying; renting has its own lifetime costs. It is an argument for buying less house, putting more down, and paying a bit extra monthly.

Run rent-vs-buy math for your city and timeline. Buying usually wins for long stays and stable markets; renting wins for short stays and expensive cities.

Frequently asked questions