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Blog posted On February 22, 2018
New to the mortgage process? You are probably seeing a lot of new acronyms you may not be familiar with. The monthly mortgage payment, for example, is comprised of “PITI” or Principal, Interest, Taxes, and Insurance. When budgeting for the cost of a monthly mortgage payment, home buyers should consider the cost of each of these components.
Principal – the total amount borrowed from the lender. For example, a borrower who puts 10% down on a home valued $250,000 will borrow a loan principal of $225,000. The monthly principal payment will stay the same throughout the life of the loan. If the borrower chooses to refinance, the loan principal will be adjusted to reflect how much of the loan is payed off. In the case of refinance, the monthly principal payment will likely change, because a new loan is issued for the remaining value.
Interest – the fee paid to borrow from the lender. Interest rates vary based on market conditions, value of the home, borrower credit profile, and more. When financing a home, there are two interest rate options, fixed-rate mortgage or adjustable-rate mortgage. Fixed-rate mortgages will have the same interest rate throughout the life of the loan and adjustable-rate mortgages can change based on the benchmark interest rate. Fixed-rate and adjustable-rate mortgages each have their own advantages based on the borrower’s financial needs. It is best to consult a mortgage professional to weigh your options before choosing a fixed-rate or adjustable-rate loan.
Taxes – each year the property is assessed, and property tax is due. Taxes vary from location to location and on the federal and state levels. Taxes will also be influenced by the age and value of the home.
Insurance – homeowners’ insurance protects against disasters and accidents. The cost of insurance varies depending on the location of the home, the age of the home, and other factors. Certain regions are more susceptible to certain types of disasters. Hurricanes are more prevalent in the Southeastern United States and tornadoes are more common in the Midwest. Coastal homes in floodplains will have higher flood insurance than homes in higher elevated areas.
In some cases, the borrower will have to pay mortgage insurance also. When a borrower puts a lower down payment on a conventional mortgage, the lender may require them to pay Private Mortgage Insurance (PMI). PMI will drop off once the loan reaches a certain loan to value amortization. When a borrower finances with an FHA loan, they are required to pay Mortgage Insurance Premium (MIP) throughout the life of the loan.
Understanding your mortgage payment is the first step toward responsible repayment, equity building, and a strong financial future. Before you start to shop for a new home, it is best to consult a mortgage professional to budget appropriately and get a realistic idea of how much home you can afford.
Sources: Investopedia, The Mortgage Reports