Lace up your sneakers, you’re buying your first home!
If the path to homeownership feels like you’re running a marathon, then it’s never too early to start training, no matter the course. While there are many ways you can prepare for this big event, one way to get ready is to learn what makes up your monthly mortgage payment. Once you understand what expenses you’re covering each month, you’ll get a better sense of how to adjust and plan your budget. Let’s break it down here.
What Your Mortgage Payment Covers
Your monthly mortgage payment is made up of four parts: principal, interest, taxes and insurance (often abbreviated as “PITI”). Once you have been approved for a mortgage, your loan officer will work with you to determine the amount and terms of your loan. They will then calculate your mortgage payment based on these four components:
Principal is the money you borrow to purchase the home. A portion of the principal is usually paid off with each mortgage payment and reduces the outstanding balance you own, which increases your home equity.
Interest is the amount a lender charges you for borrowing the money to buy the home. Many factors determine mortgage rates, but usually the interest rates can vary according to risk. Items that affect your interest rate include credit score, down payment, loan program, loan type, property type and loan to value.
Taxes are annual property taxes you pay as a homeowner to local governments to fund public services (community schools, roads, police, etc.), and are usually a percentage of the assessed property value. Before buying a house, be sure you understand what you can expect to pay for local property and county taxes.
Insurance refers to your homeowner’s insurance and helps protect against financial loss from fire, natural disasters or other hazards. If you’re financing your home with a mortgage, you’ll be required to have this insurance. Also, keep in mind if you’re making less than a 20 percent down payment, you’ll most likely need private mortgage insurance (PMI) which protects your lender if you stop making payments on your loan.
Remember, many loan quotes will only include your principal and interest. You’ll also need to factor in the taxes and insurance to calculate your total monthly mortgage payment.
Your Escrow Account
If you’re taking out a loan on your first home, it can be a little overwhelming to think about making a monthly mortgage payment, as well as managing new expenses such as property taxes and home insurance premiums. One way to keep yourself organized and ensure you save the funds needed to pay these expenses is to set up an escrow account with your lender. Keep in mind if you’re putting less than 20% down, and you’re a first-time homebuyer, you may not have a choice – your lender may require you to have an escrow account.
With a mortgage escrow account, you pay your lender 1/12 of your annual real estate tax bill, homeowner’s insurance, and PMI (if you need it) premium each month, along with your regularly scheduled payment. The lender then holds the funds in an escrow account and distributes them to your county assessor and insurance companies as the payments are due.
Once you become a homeowner, you’ll find that your monthly mortgage payment is a tad more complicated than writing the monthly rent check. But remember, with each payment you make, you’re building equity in your home – and getting that much closer to achieving your goals and triumphantly crossing the finish line.