A special thank you to George for sharing such an informative post regarding mortgage payments and terms. It explains it all a must read for first time home buyers or anyone else looking to buy!
A common assumption that is often made by those in the Mortgage Industry is that Homeowners understand what makes up their monthly mortgage payment, but in reality many do not. So it is important that Loan Officers take the time to explain to each of their Borrowers, not only how much they will be paying each month, but also the different components that make up their monthly payment.
A common term in the Mortgage Industry when referring to the monthly mortgage payment is PITI. PITI simply stands for:
Principal - This is the portion of the monthly payment that reduces the remaining balance of the money that was borrowed.
Interest - This represents the cost of borrowing the money, and is stated as a percentage of the outstanding balance on the loan. On a 30 year fixed loan, the total interest is almost the same amount as the amount of money that was borrowed.
Taxes - This is the money that is collected each month as part of your monthly payment, so that the Lender can pay the town the property when they come due. In most towns in Connecticut, property taxes are collected every 6 months, with the exception of one town that collects taxes every 3 months and 6 other towns that collect taxes just once per year. Taxes will differ from town to town, depending on the mill rate that the town sets for that year. The mill rate is calculated as a percentage of each $1,000 that the town assesses the property value at.
Insurance- This is the money that is collected each month as part of your monthly payment, so that the Lender can pay the Homeowners Insurance premium to the Insurance Company each year. Homeowners Insurance is required on most loans to protect the Homeowner and the Lender for a loss or damages caused by fire, or other similar things. Homeowners Insurance, also provides protection for theft, and injury.
These are the 4 components that make up the PITI, but there may be one other fee that could also be part of a monthly payment:
Private Mortgage Insurance (PMI) - If a Borrower makes a downpayment that is less than 20% of the selling price of the house that they purchase, they will need to pay PMI. PMI is required by the Lender to protect the Lender in case the Borrower defaults on the loan, and the Lender has to foreclose on the property. When a Borrower is required to pay PMI, it will be calculated as a monthly amount that will be collected each month as part of the monthly payment. A Borrower will be required to pay PMI until the Borrower has acquired 20% equity in the property on a Conventional Loan. On a FHA Loan the Borrower will continue to pay the Mortgage Insurance (MI) each month until the Principle Balance has been reduced to 78% of the beginning loan amount, and the Borrower has been paying it for a minimum of 5 years.
Hopefully the above explanation helps homeowners better understand what makes up their monthly mortgage payment, and why it is a part of their payment.