Mortgage payments are the largest expenditure in American households, costing families 33.8% of their annual income last year—and the cost of owning a home increased by 1.6% from 2020 to 2021, according to the Bureau of Labor Statistics.
Understanding why your mortgage payment may increase year over year can help you plan ahead to meet your financial obligations.
Why did my mortgage payment increase?
Mortgage payments can fluctuate because of changes in the economy like interest rates rising, but can also change for other reasons, such as if your property tax or homeowners insurance premiums increase.
Later on, we’ll look into possible reasons why your mortgage payment can increase and how you can get prepared before it happens.
Escrow payment
Escrow accounts are used by homeowners to set funds aside to pay for their property taxes and homeowners insurance premiums.
After purchasing your home, your mortgage loan servicer will transfer a portion of your monthly mortgage payments to an escrow account and hold the funds for you until your insurance or taxes are due. The amount you pay into your escrow account varies each year based on the cost of your property taxes, the property value of your home, and your homeowners insurance premium.
For instance, if a high school in your district wants to renovate their gymnasium, your tax bill may increase for a certain number of years to fund the project. During this time, the amount you pay into your escrow account for taxes will increase, which increases your overall monthly mortgage payment.
The same is true if your property value rises. When you move into your home, the property value may be reassessed at a higher value than you loan servicer anticipated. In this case, the funds in your escrow account may not cover your entire tax bill and you may have to pay out of pocket to make up the difference.
Adjustable rate mortgage (ARM)
An adjustable rate mortgage (ARM) is a type of mortgage loan with a variable interest rate tied to the market.
“ARMs have a fixed initial period, where the interest rate and payment are fixed for five, seven, or 10 years, but then move into an adjustable rate after the initial period,” says Pete Boomer, mortgage executive vice president at PNC Bank. “Depending on what interest rates are doing, that rate can go up or down, which influences your mortgage payment.”
For instance, let’s say you have a 30-year ARM that has a fixed period of 10 years. For the first decade of your mortgage loan, you would pay a lower fixed rate. After the initial period ends, your interest rate may increase if current market rates are higher for the remainder of the life of the loan.
Late fees
Your mortgage loan officer may charge you a late fee for missing your monthly payment.
Lenders may consider your payment late if it is not processed by the due date or may offer you a grace period of up to two weeks before charging you a late fee. These fees are stated as a percentage of your mortgage payment, typically ranging from 3%–6% of your payment.
For instance, let’s say your mortgage payment is $2,000 a month and your late fee is 5% of your mortgage payment. If you miss one payment, your lender may charge you an additional $100 per missed payment.
If your lender allows you to schedule automatic payments, it’s important to calculate how long it takes your payment to process to avoid accidentally missing your due date.
Service member benefits
The Servicemembers Civil Relief Act (SCRA) was enacted to protect active-duty service members from paying high interest rates while they are serving their country.
The SCRA limits interest rates on mortgage loans to 6% per year while the servicemember is actively serving and for the 12 months following their act of service. You are still required to pay your mortgage loan payments, but the amount you pay during this time may be reduced if your original interest rate was higher than 6%.
After the 12-month period ends, you will resume paying your original mortgage interest rate and payments. It’s important to note that these benefits don’t apply to veterans. If you are a veteran looking for servicemember benefits that apply to your mortgage loan, consider looking into a VA loan.
Prepare for increased mortgage payments
Ideally, homeowners are made aware at the time of their loan origination that their monthly mortgage payment can potentially increase—especially if they took out an ARM or use an escrow account to pay their taxes and homeowners insurance. But other mortgage increases such as late fees may happen unexpectedly, such as if you face a financial emergency.
There are steps you can take to financially prepare yourself if you have to pay a higher monthly mortgage payment.
Speak with your lender. It’s important to keep in contact with your lender so they can inform you of possible rate changes, and how they can affect your mortgage payment before it happens.
If you want to take out an ARM, your mortgage lender should review all the possible increased payment scenarios that may arise in the future. This means making sure you can comfortably afford your payments every month without sacrificing your current lifestyle, says Boomer.
Although ARMs have become more popular amongst homebuyers who plan to stay in their home for a short time period, it’s also important to consider whether you can afford your payment in the event you cannot sell your home before the fixed period ends.
Review your budget. If you are aware your payment may increase in the future, such as in an ARM or because your property taxes may increase, you can begin budgeting ahead of time to prepare your finances.
Ask yourself if you would be comfortable making your mortgage payment if it increased today. If the answer is no, look for ways you can dial back on discretionary spending, says Boomer.
Decrease your loan amount. Consider putting down a larger down payment to lower your overall mortgage loan—if this is a possibility for you. A larger down payment will usually decrease your monthly mortgage payment; saving money each month can help you afford future payment increases.
“Before you enter into any agreements, I highly suggest you take a look at the worst case scenario,” says Boomer. “If your payment were to increase, would you be able to comfortably make your payments?”