A mortgage payment is comprised of four parts – Principal, Interest, Taxes, and Insurance; often referred to as P.I.T.I. Here we dissect the anatomy of a monthly mortgage payment piece by piece.
Principal is the initial amount of your loan; how much money you borrowed from the bank. The bulk of your monthly mortgage payment goes toward the principal amount, however, typically, the first 7-to-10 years most of your payment goes towards interest. This is because the bank wants to protect their investment upfront. The bulk of the principal being paid down happens during the second half of the life of your loan. You bank can provide a copy of your amortization schedule upon request.
There are exceptions to this general rule. For instance, if you do not put down at least 20 percent of the loan amount, you must get private mortgage insurance (PMI). PMI protects the lender in case you default on your loan. Once you have obtained 20 percent equity in the home, you can refinance and drop the PMI, saving some money.
Principal and interest go hand in hand. Interest is the amount the bank charges you and is based on the interest rate you locked when purchasing your home or refinancing your home. This amount can change depending on what type of loan you receive. Here’s where it can get tricky. If you have a fixed-rate mortgage, the principal and interest portion of the payment remains the same for the duration of the loan. If you have an adjustable-rate mortgage (ARM), both principal and interest are fixed for a specific time and then adjusts after the initial term of the loan. Consult your mortgage lender for more information.
The government also gets a piece of the pie. The amount of tax you pay is based on the home’s current value and can change as the value of your home changes. This also affects your monthly payment, which can go up or down based on taxes owed. Good news is, this swing is normally not too substantial. Your annual taxes are divided into 12 monthly installments and held in escrow until your taxes are due. Your annual taxes are divided into 12 monthly installments and held in escrow until your taxes are due. Most lenders will require you to include the taxes in your monthly payment. This is because when an individual defaults on their taxes, property taxes are the first lien assessed against you.
You can’t own a home without insurance, which is for your own protection. Similar to taxes, a portion of your monthly mortgage payment is earmarked for insurance and held in escrow with the bank servicing your loan and paid directly to your insurance company.
Tally these four components and you’ve got your monthly payment.
While homebuyers spend a great deal of time and energy researching mortgage rates and lenders, it is also imperative to understand every aspect of the loan before you sign. A closing disclosure is presented for you to review at closing and breaks down each of these sections, as well as other fees such as appraisals and closing costs. By reviewing each component of your PITI, a lender can answer any final questions you have before signing on the dotted line.