When a family buys a house, it is typical to finance it using a long-term loan called a mortgage. Over the years that follow, the homeowner pays back the principal, along with interest that accrues. The collateral for a mortgage is the home, as well as the surrounding land. That is simply a general idea of how a mortgage works, though. Since a home is such a huge purchase — the largest most people make in their lives — it is important to understand the specific elements that make up a mortgage payment.
The four primary components of a mortgage payment are principal, interest, taxes, and insurance.
What is PITI?
The four primary components of a mortgage payment are referred to as PITI, short for principal, interest, taxes, and insurance. Here is a look at each of those pieces:
Component #1: Principal
When you send a lender money toward your mortgage each month, some of it goes toward paying down the balance that you owe. The part of your payment that goes toward that sum, the principal, is typically smaller at first and becomes a larger percentage of payments over time. The payment you make each month will stay the same, though, provided you have a fixed-rate mortgage (FRM).
The payment you make each month will stay the same, provided you have a fixed-rate mortgage (FRM).
Component #2: Interest
In exchange for giving you a loan, the money that the lender gets in return (beyond repayment of what you borrowed) is called interest. The lower your interest rate, the lower your monthly payments will be. Lower rates also allow you to take out larger mortgages (and afford costlier houses).
Component #3: Taxes
Often property taxes are included in the monthly payment too. The amount that is included is one-twelfth of the annual tax charge. In these cases, the lender holds the money throughout the year within an escrow account. When the taxes are due (in May and October in Minnesota), the lender uses the saved money to directly pay your taxes.
The lower your interest rate, the lower your monthly payments will be.
Component #4: Insurance
Homeowner’s insurance, a protection lenders require to finance a home, is the fourth component of a mortgage payment. In the event of property damage, the lender is protected by these policies, with the applicable portion of the payment sent on to the insurer. Another type of insurance, private mortgage insurance (PMI), is also necessary if your down payment was below 20 percent and you have not yet established 20 percent equity.
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It is important to get the lowest interest rate possible so that your monthly payments can be low as well. At Best Advantage Mortgage, we use our network of trustworthy lenders to get the lowest rate in the Minneapolis area. Meet our team (all 59 Google reviews currently 5 stars)!
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