A monthly payment is the amount a borrower is required to pay each month until a debt is paid off.
Monthly payments are specified in loan documents — how they are calculated, when they are due, and what happens if they are not made as agreed.
A credit card minimum payment, for example, might be the amount of interest due — which is the monthly interest rate times the account balance – plus two percent of the balance.
Most installment loans, like auto loans or home mortgages, have payments designed to pay the loan in full by the end of the loan term. This structure is called fully-amortizing. Each equal installment covers the previous month’s interest charge, but the payment is a little higher than that. The extra is used to reduce the loan balance. The next month, the balance is a little bit lower, so there is less interest expense, and more left over to reduce the loan. As the balance gets smaller each month, the interest charge continues to drop and each month more of the payment is available for reducing the balance. At the end of the loan term, the balance is zero.
Monthly payment, however, is not always calculated this way. For example, some mortgages allow interest-only payments for a few years before they become fully-amortizing. The payment only covers the interest due, and so the balance is not reduced at all.
Obviously, this can’t go on forever or the loan would never be repaid. So what happens is something like this: A $100,000 mortgage at a 4.0 percent interest rate might have interest-only payments for the first five years. Instead of paying the “regular” payment of $477.42, the borrower pays just $333 per month.
In five years, though, the entire $100,000 is still owed, and now there are just 25 years left to repay it. So the payment increases almost $200 to $527.84 per month for the remaining 25 years.
Sometimes, when a home buyer talks about a monthly payment, he or she means the entire housing expense – the mortgage principal and interest, but also the monthly property taxes and homeowners insurance. This payment is called a PITI payment.
The LendingTree home affordability calculator estimates taxes and insurance for you and includes them in your payment.
When you get a loan, you are going to face making monthly payments to repay your debt for a considerable amount of time. This monthly payment will probably be one of your bigger expenses, so it is important to get a loan that you can manage paying back. Otherwise, you might find yourself defaulting on the loan and putting your assets and your credit at stake.
Here are the major components to determining your monthly payment:
The larger your down payment, the smaller your monthly payments will be. Regardless of the type of loan, your lender will probably set a minimum down payment. Your minimum down payment is the amount of money you are required to put down at closing. You can certainly put down more if you want to lower your monthly payments, but be careful not to leave your savings destitute. Even though lower monthly payments can help you stay within your monthly budget, if making a larger down payment cleans out your savings, you might find yourself scrambling for cash in the event of an emergency.
When shopping around for loans, one of the deciding factors is your interest rate. Part of your monthly payment will go toward interest, so finding a loan with the lowest interest rate can help keep your payments manageable. Even a slight difference in percentage rates can save you money. For example, a $100,000 mortgage at a fixed-rate of 6.75 percent for 30 years will have a monthly payment of $648.60. But the same mortgage at 7.00 percent will have a monthly payment of $665.30.
The larger your loan amount, the more you will be expected to pay each month. When you get a loan, your lender will present you with the maximum loan amount. You do not have to spend up to the maximum loan amount, especially if you want to keep your monthly payments low so you can save and invest more money elsewhere. It is important that you set a budget for yourself and determine what you can afford in loan and housing expenses and not just go by what your lender says you can afford. If you overextend yourself, you could find yourself defaulting on your loan and losing your home.