What Is a Mortgage?
A mortgage is a loan secured by real estate. In other words, in return for the funds necessary to purchase a home, a lender, gets your promise to pay back the funds over a certain period at a certain cost. Backing your promise to repay is the property. Should you default, or stop paying, the loan, the lender would take over ownership of that property. Typically, the repayment of a mortgage occurs through monthly payments.
What Does My Mortgage Payment Include?
Usually, your monthly mortgage payment is made up of four parts:principal, interest, taxes and insurance (PITI), but it can also include maintenance expenses, such as condominium homeowners’ association dues. The principal is the amount in your monthly payment that reduces the original amount borrowed. Over the life of a standard mortgage loan, the entire original amount borrowed is generally scheduled to be fully paid off, or amortized. The interest rate is the fee charged to borrow the outstanding balance for the past month. In addition, a monthly amount may be collected and held in a separate escrow account to cover property taxes, homeowner’s insurance and mortgage insurance. Your lender uses the money in the escrow account to pay your tax and insurance bills, as they come due.
Mortgage Payment Breakdown
Principal + Interest + Taxes + Insurance = PITI
- Principal is the amount of money you borrow based on the sale price of the home. In the early stages of your mortgage term, your monthly payment includes only a small portion that repays your original principal. As you continue to make payments through the years, a greater portion of your payment goes to reduce the principal.
- Interest is the cost of borrowing money. In the early stages of your mortgage term, your monthly payment is mostly interest.As you continue to make payments through the years, a smaller portion of your payment goes to interest.
- Taxes are paid by homeowners to local governments, and are usually charged as a percentage of theassessed property value. Tax amounts vary depending on where you live.
- Insurance offers financial protection in the event of a loss and has two main components that can be included as part of your payment.
Homeowner’s or hazard insurance protects you against financial losses on your property as a result of fire, wind, natural disasters or other hazards. Most lenders will require you to have a homeowner’s insurance policy on your home because it will help protect their investment as well as yours.
Mortgage insurance (MI) is required on certain loans to protect the lender against financial losses if the borrower fails to repay the loan.Usually, whenever the down payment is less than 20% of the home’s purchase price, lenders require some type of insurance. Loans insured by FHA/HUD programs require a mortgage insurance premium (MIP), while VA loans require a funding fee. Conventional loans, or those without government backing, can be insured with Private Mortgage Insurance (PMI).
Typically, the portion of your monthly mortgage payment that covers taxes and insurance is held in a special account by your lender.Then,when these bills are due, the lender forwards payment on your behalf to the local government or insurance company.This process is known as escrow. Using escrow for taxes and insurance is an option for the homeowner and not a requirement. Once your mortgage is paid in full, you are still responsible for taxes and hazard insurance.