Key Terms Regarding Mortgages
Everyone knows that mortgages allow homebuyers to purchase homes by making monthly installments, but there’s more to those monthly payments than first-time homebuyers might think. Yes, a portion of your mortgage payment goes toward paying off the initial loan amount, but there are several other things to consider when determining what kind of home you can afford. Let’s take an in-depth look at all of the components of a monthly mortgage payment.
Understanding Mortgage Principal
Mortgage principal is the actual amount borrowed to purchase a home. For example, if you were to take out a loan to purchase a home priced at $250,000, then $250,000 would be your principal. A portion of each monthly mortgage payment goes to paying down the principal, but mortgages are structured so that a larger percentage of the monthly payment goes toward interest during the first few years. As time goes on, the portion of the monthly payment dedicated to paying down the principal gradually increases. During the final years of the mortgage, most of each payment will go toward paying down the actual loan amount borrowed, but homebuyers shouldn’t be surprised to find that the principal decreases very slowly at first.
What Is Mortgage Interest?
When a lender allows a borrower to take out a mortgage, that lender is taking a risk. Nobody goes into the home buying process with the intent to default, but let’s face it: foreclosure sometimes happens. And when it does, banks can sustain substantial losses. Interest is the lender’s reward for taking on the risk of extending credit to homebuyers. The bigger the risk, the higher the interest rate will be. As you might imagine, interest rates can have a substantial impact on the long-term cost of purchasing a home. The difference between 4.5% and 6% might not sound like much on paper, but over the course of a $250,000, 30-year, fixed rate mortgage, that 1.5 percent adds up to more than $80,000 when everything is said and done.
Taxes on Your Mortgage
Yearly property taxes are also included as part of the monthly mortgage payment. The lender collects these taxes from the homeowner, holds them in an escrow account, and pays them at the end of the year. State and local governments assess these taxes to fund schools, infrastructure maintenance, and public services such as police and fire departments. It’s important to note that property taxes can vary widely, depending on location and market conditions. The national, per-capita average is about $2,000 per year, but some states charge less than half, while others require homeowners to pay nearly double the national average.
It’s important to note that property taxes can vary widely, depending on location and market conditions. The national, per-capita average is about $2,000 per year, but some states charge less than half, while others require homeowners to pay nearly double the national average. Property taxes can also change over time. For example, homeowners who make improvements that increase their home values may also face higher tax obligations. Even those who make no improvements can see their tax obligations increase over time if their homes increase in value due to market conditions.
What is Mortgage and Homeowner’s Insurance?
As a homeowner, you’ll be required to carry a homeowner’s insurance policy. Homeowner’s insurance protects you against liability for accidents occurring on your property and covers losses that could result from burglary, fire, natural disasters, or other perils.
If you make a down payment of less than 20%, then you’ll also be required to carry mortgage insurance. Mortgage insurance protects your lender against the losses that could result if you default on your home loan. It might seem strange that you have to pay for an insurance policy that protects your lender, but if you have less than 20% to put down on your home, you’re considered a higher risk borrower. If you want to get financed, then you’ll have to play ball.
That’s a Lot to Remember About Mortgages
If you have trouble remembering all the little details that go into your mortgage payment, just remember the acronym PITI: Principal, Interest, Taxes, and Insurance. Make sure you take all of these factors into account when figuring out how much you can afford to spend on your next home.
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