When you're buying a home, it’s likely you’ll be paying your mortgage for quite some time. That’s why it’s essential to understand the components that make up your monthly mortgage payment. There are technically four parts: mortgage principal, interest, taxes, and in some cases, CMHC insurance - principal and interest being the largest. 

What is a Mortgage Principal?

A mortgage principal is the initial amount you borrow from a lender to purchase a home. This amount is typically the price of the home minus your down payment. However, if your down payment is less than 20%, you might also have to pay CMHC mortgage insurance, which can be rolled into your principal.

Example 1:

Let’s say you purchase a home for $700,000 and make a 20% down payment, which equals to $140,000. Your initial mortgage principal would be $560,000. In this scenario, because your down payment is 20%, you would avoid the additional cost of CMHC insurance.

Example 2:

Let’s say you purchase the same home for $700,000, but this time you only put down 10%, which equals to $70,000, your mortgage principal increases to $630,000 due to your smaller down payment. In this scenario, you would also have to pay a mortgage insurance premium, which is usually between 2.8% and 4%. In this case, if your mortgage insurance was on the higher end at 4%, it would cost an additional $25,200 (4% of $630,000). If you choose to add your insurance to your total mortgage amount, your total principal would be $655,200.

What about Interest?

Interest represents the cost a lender charges you for borrowing money. It's usually a yearly percentage of the mortgage principal. How interest is calculated and applied can significantly impact how much you pay on a monthly basis and over the life of your mortgage.

Fixed-rate Mortgage

With a fixed-rate mortgage, the interest rate will remain constant throughout your mortgage term. This means that the amount of money you pay towards the principal and interest does not change over time. This makes monthly budgeting a lot easier because there are no surprises. 

 Scenario 1:

If you lock in a fixed rate at 3.5% per year, a typical monthly payment might be split into a portion for the principal and a portion for interest. This will remain the same over your mortgage term.

Variable-rate Mortgages:

For variable-rate mortgages, the interest rate can fluctuate with the market. While your total payment amount remains the same, the amount of your monthly mortgage payment going toward your principal and interest might change.

Scenario 2:

If you have a variable-rate at 3% which eventually adjusts to 3.5%, the total payment remains the same but the amount going toward the interest increases, which decreases the amount paid toward the principal.

Understanding these components of your mortgage can help you make informed decisions about which type of mortgage might work best for your financial situation and how changes in interest rates might affect your payments.