Written by Danny Frank for www.chron.com
Do you know what you’re paying for every month?
When you decide to buy a new home, a good first step is to determine how much mortgage you can afford. After talking to a mortgage broker or using a mortgage calculator, you may find a payment amount that falls well within your monthly budget.
Keep in mind the mortgage payment is only one of the monthly expenses you are responsible for with a new house. So, what else are you paying for?
Your monthly payment typically is made of four components: principal, interest, taxes, and insurance – often referred to as PITI.
Principal. Principal is the amount you originally borrow. Early in your mortgage’s term, your payments will be applied mostly to the loan’s interest. As the loan progresses, you’ll pay off more principal.
Interest. Interest is money the lender charges to take the risk on your loan. The interest rate on your loan has a direct correlation to the size of your payment. That is, a higher interest rate leads to higher monthly payments. For most home buyers, higher interest rates reduce the amount of money they can borrow, and lower interest rates increase it.
Taxes. Property taxes can account for a significant amount of your monthly payment. These taxes for local schools, city and county services, and other local entities are based on the tax rate for each of those taxing authorities and the appraised value of your property. Instead of a large tax bill coming due at the end of the year, many property owners pay their property tax as part of their monthly payment. The annual amount is divided by the total number of payments in a given year. The lender collects these payments and holds them in escrow until they are due, and then the lender uses the money to pay the bill.
Insurance. There are two types of insurance coverage that may be included in your monthly payment. The first type, property insurance, protects your home and possessions from fire, theft, and other events your policy outlines. The second type of insurance is private mortgage insurance (PMI). When a home buyer does not put down at least 20 percent on the home, most lenders require PMI. This insurance offers the lender some protection in the event the borrower is unable to repay the loan. PMI coverage can be dropped once you attain 20 percent equity in the home.
While these four components make up a typical monthly payment, some lenders allow homeowners to pay taxes and insurance on their own. In this scenario, you’ll have a lower monthly payment, but you must make sure you have the money available to pay property taxes and insurance when those bills come due.
An amortization schedule shows how much of your monthly loan payment is being applied toward interest costs and how much to reduce the outstanding balance of your loan. The amortization chart details the month-by-month progression of your mortgage payments from mostly covering interest to mostly covering principal. Many lenders allow you to pay extra each month to pay off principal early and pay less interest over the length of the mortgage.
Your Realtor can be a great resource to help you understand these components plus other costs associated with homeownership.