PITI: The Components of a Mortgage Payment.
Do you understand what each piece of your mortgage payment means? For most of us, there are four main pieces, commonly referred to as PITI. These pieces are broken down below to explain what each one means, why it matters, and how they work together.
Once the size and term of the loan have been determined, there are four factors that play a role in the calculation of a mortgage payment. Those four items are principal, interest, taxes and insurance (PITI). As we look at these four factors, we’ll consider a $100,000 mortgage as an example.
A portion of each mortgage payment is dedicated to repayment of the principal. Loans are structured so that the amount of principal returned to the borrower starts out small and increases with each mortgage payment. While the mortgage payments in the first years consist primarily of interest payments, the payments in the final years consist primarily of principal repayment. For our $100,000 mortgage, the principal is $100,000.
Interest is the lender’s reward for taking a risk and loaning money to a borrower. The interest rate on a mortgage has a direct impact on the size of a mortgage payment – higher interest rates mean higher mortgage payments.
So, for most home buyers, higher interest rates reduce the amount of money they can borrow, and lower interest rates increase it. If the interest rate on our $100,000 mortgage is 6%, the combined principal and interest monthly payment on a 30-year mortgage would be something like $599.55 ($500 interest + $99.55 principal). The same loan with a 9% interest rate results in a monthly payment of $804.62.
Real estate taxes are assessed by governmental agencies and used to fund various public services such as school construction and police- and fire-department services. Taxes are calculated by the government on a per-year basis, but individuals can pay these taxes as part of their monthly payments. The amount that is due in taxes is divided by the total number of monthly mortgage payments in a given year. The lender collects the payments and holds them in escrow until the taxes are due to be paid.
There are two types of insurance coverage which may be included in a mortgage payment. Like real-estate taxes, insurance payments are made with each mortgage payment and held in escrow until the bill is due. The first type of insurance is property insurance, which protects the home and its contents from fire, theft and other disasters.
The second type of insurance is PMI (mentioned above), which is mandatory for homeowners who purchase a home with a down payment of less than 20% of the home’s cost. This type of insurance protects the lender in the event the borrower is unable to repay the loan. Because it minimizes the default risk on the loan, PMI also enables lenders to sell the loan to investors, who in turn can have some assurance that their debt investment will be paid back to them. PMI coverage can be dropped once the borrower has at least 20% equity in the home.
While principal, interest, taxes and insurance comprise a typical mortgage, some borrowers opt for mortgages that do not include taxes or insurance as part of the monthly payment. With this type of loan, borrowers have a lower monthly payment, but must pay the taxes and insurance on their own.
– via Investopedia
Key terms – in plain English
When it comes to understanding your mortgage, there’s more than just PITI. Those are the four pieces of your mortgage payment, but there’s a lot to know and understand beyond your payment – like types of mortgages, types of insurance, and what all those letters and numbers the realtors throw around really mean.
Adjustable Rate Mortgage (ARM) – A mortgage that has a fluctuating APR.
Amortization – A process that allows the repayment of the interest and principal of a loan in equal installments, but non-equal proportions, during a pre-determined repayment period.
Annual Percentage Rate (APR) – Interest that is calculated annually, based on the principal balance of the loan.
Borrower – The person, or entity, that is requesting the loan.
Debt – The responsibility to re-pay a borrowed amount at some regular interval. These can be both private, and unsecured, such as credit cards; or, they can be secured such as an auto loan. They can also be “public” or government obligations, such as student loans.
Debt-to-Income Ratio – The relative proportion of your debt compared to your monthly gross income.
Down Payment – A payment that reduces the principal value of the loan made during a home purchase.
Escrow – An account setup by your legal representative with a financial entity that holds your money, to be used for a pre-determined purpose.
Fixed Rate Mortgage – A mortgage that sets a single fixed interest rate, for the full term of the loan.
Gross Income – Your monthly income, before taxes and deductions.
Home Equity – The value of your home in excess of any principal owed on your mortgage.
Interest – The rate a lender charges to support the risk they inherit by issuing a loan.
Lender – The bank, or financial institution, that is issuing the loan.
Loan-to-Value Ratio (LTV) – The relative proportion of a loan compared to the appraised value of a property.
Lump Sum – A payment that reduces the principal value of the loan, made anytime after a home purchase.
Principal – The actual loan amount based on the purchase price of the home, less any down payment amount.
Private Mortgage Insurance (PMI) – Insurance that is required for certain mortgages, depending on the lender’s requirements.
Property Tax (Real Estate Tax) – The taxes assessable on real estate property. Commonly set at the county or municipal level.
Pro-rate – A function that takes a lump amount and divides it, proportionally, between some pre-set quantities of payments.
Refinance – A process by which a borrower and lender pay off the preceding mortgage loan and replace it with a new one based on the current principal value and any changes to interest rate.
Repayment Term – The number of years, or months, required to repay the full amount of a loan, including total interest payments due.
– via www.homefinder.com
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