What's in a Mortgage Payment?
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A monthly mortgage payment includes at least two parts: an amount that goes
toward the principal of the loan (the money you've
borrowed) and a second amount that goes toward interest (the cost of
borrowing the money). For most homeowners, however, there
is also a third part of the mortgage payment: an amount that is paid into an
escrow account that the lender maintains for you to pay for
things like homeowners hazard insurance, property taxes, condominium and
association fees and mortgage insurance (if applicable).
This is the element of the monthly payment that can go up or down even in a
fixed-rate mortgage.
Together, these elements are called PITI:
-
— Principal I — Interest T — Taxes I — Insurance
Your tax and insurance costs
Homeowners must pay property taxes and they
must have some type of homeowners insurance. Depending on state laws and
other
variables, most lenders require homeowners to pay into what is called an
"escrow account." In this account, the lender or mortgage
servicer keeps enough money to cover your property taxes and homeowners
insurance. You pay into this account each month as part
of your mortgage payment. When your taxes are due, the lender/servicer pays
them for you. The same is true for your insurance.
The lender/servicer sends you a periodic statement showing how much is in
this account. You can compare the statement with
your property tax bill and your homeowners policy to ensure that the right
amount is being held to cover the payments.
The Real Estate Settlement Procedures Act (RESPA), which is enforced by the
U.S. Department of Housing and Urban Development,
(HUD), is the major law covering escrow accounts.
It is important to maintain the required property
insurance on your home. If you don't, your lender/servicer can buy insurance
on your
behalf. This type of policy is known as "force placed insurance"; it usually
is more expensive than typical insurance, and it provides less coverage.
If you're buying a house, most sellers disclose the amount of the annual
property taxes on the house when it is listed for sale. If they
don't, you can easily get this information from your local property tax
assessor. A local insurance agent can give you an idea of the annual
insurance cost. Divide each of these numbers by 12 and add them to the
principal and interest to get the estimated total monthly payment.
What is private mortgage insurance?
If a buyer puts down less than 20 percent of
the selling price on the mortgage, lenders may require the buyer to buy
another type of
insurance called private mortgage insurance (PMI). This provides insurance
to the lender in case the buyer is not able to repay the loan
and the lender is not able to recover costs after foreclosing the loan and
selling the property.
The annual cost of PMI can vary but usually is between .19
percent and 1 percent of the total loan value, depending on the loan terms
and loan type. PMI can be paid up front but most buyers prefer that it be
included in their mortgage payment. The cost can vary based on
several factors that include: loan amount, loan-to-value ratio, occupancy
(primary home, second home, investment property),
documentation provided at loan origination, and probably most of all credit
score.
Once the principal of the loan reaches 80 percent (the
owner has 20 percent equity in the home), the PMI is usually no longer
required and can be canceled, although you may have to prove your equity by
having a new appraisal done to show that the house
is worth at least 20 percent more than you owe on it. (Note: Some lenders
may require that PMI be paid for a fixed period even if
the principal reaches 80 percent.) The cancellation request must come from
the servicer (the company you send your mortgage
payment to) of the mortgage to the PMI company that issued the insurance.
Note: PMI may be waived or avoided through some types of
government or other loans. Check with your lender to determine
your situation.
A PITI Payment with PMI
Maria and George have found a home that costs
$150,000. They are able to make a down payment of 5 percent, or $7,500. The
annual
property taxes are $1,650 and the annual homeowners insurance is $780. These
payments are made in monthly installments in their
mortgage and are held in an escrow account. When their taxes and insurance
are due, the lender (or mortgage servicer) makes the
payments for them. Because their down payment is less than 20 percent, Maria
and George will pay PMI as part of the mortgage
payment. With a 30-year fixed mortgage and an interest rate of 6 percent,
the PITI with PMI is as follows:
- Principal and Interest (P and I): $854.36
- Monthly Property Taxes (T): $137.50
- Monthly Property Insurance (I): $65.00
- Private Mortgage Insurance (PMI): $85.50
- Total payment: $1,142.36
Making bi-weekly payments
Paying half your mortgage every two
weeks instead of a full payment once a month can be done with most any type
of loan but is most common with a 30-year fixed-rate loan. Doing so pays
your mortgage more quickly because you pay the equivalent of 13 months of
payments each year. For people who can budget to make a half-payment every
two weeks, this offers more rapid building of equity.
You can choose to do this on your own. Many people have it automatically
deducted from their checking accounts. Because your payments are applied to
the
loan every 14 days, the principal amount decreases faster, saving you more
in interest costs. Your loan term shortens to 22 or 23 years, providing a
substantial decrease in total interest costs.
Paying additional principal
Another option — if you can afford a slightly
higher monthly payment — is to achieve the same savings with monthly
payments. To do this, you would need
to pay an extra amount of principal to your total mortgage each month. Using
the above example, with a mortgage payment of $997, you would add $83 a
month ($997 divided by 12) toward the principal (You will need to specify
the extra amount for "principal only" on your payment.), making your payment
$1,080. The interest savings would be the same and the loan would be paid
off about seven years early, but you wouldn’t have to commit to making
payments every two weeks.
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