Part of being a responsible and successful homeowner and borrower is understanding what goes into your mortgage. While you may not need to track the route of every single penny, it helps to understand the various components of your total monthly payment. This means understanding “PITI.”
For most borrowers, the mortgage payment is made up from four different aspects: principal, interest, taxes, and insurance. Collectively known as “PITI,” this is a simplified way of separating the different components of your total loan. If you understand PITI, you’ll have a better grasp on the total costs of homeownership.
What is PITI?
The “principal” is the total amount that it would take to repay and close the mortgage. (This is also referred to as the “balance.”) The principal section on your mortgage payment, therefore, goes towards paying down the total amount you owe.
This is simply the amount you own before any interest is added. For most loans, this section makes up the greatest portion of the monthly payment, and while it will increase (and the interest payments section will decrease), it usually makes the bulk of your monthly bill.
This is simply the fee you pay for borrowing money. Acting like a financial incentive to lend money, the interest rate is added to ensure that lenders are motivated to make home loans. So while interest is not popular (it would be great if home loans were available without interest), having this addition ensures that loans continue to be available.
What’s the Value of a Low Rate?
We all want a low interest rate, but does it really make a major difference in your loan payment? Does a 0.5% or even a 1% reduction in interest greatly impact your mortgage?
The larger your mortgage, the more an interest rate will impact your payment. Using our mortgage calculator, we can estimate the difference a change in interest might have on your loan.
Let’s suppose you are borrowing $500,000 at an interest rate of 4% on a 30-year mortgage. (For simplicity, we are leaving downpayment off.) Under these conditions, your monthly P&I (principal and interest) would be $2,387. But if we reduce the interest rate to 3.5%, that number is reduced to $2,245 a month. If we go down to 3%, the P&I is $2,108.
In this scenario, reducing the interest 1% resulted in a monthly savings of $279. That might not seem like much, but over the course of a 30-year loan, it results in a savings of $100,440!
We could change numerous variables, but the result would be the same: a low interest rate can make a significant difference on your mortgage.
Note: Amortization Impacts Principal and Interest Amounts
Even on a fixed-rate loan (with a fixed monthly payment), the total amount you pay towards the principal does not remain the same. At the beginning of the loan, you usually pay more towards the interest
If you are a property owner, you’ll have to pay taxes. Governments at the state and local level collect taxes on all types of properties, including residential property. For many homeowners with a mortgage, these taxes are not paid directly to the government. Instead, you pay an additional amount as part of your mortgage payment, then the bank or lending institution pays the property taxes.
This is one of the hardest components of PITI to predict, as taxes fluctuate significantly from state to state, county to county, and city to city. However, they are usually based on the value of the home, such as 5% or 10%.
Why are Taxes Part of the Mortgage Payment?
Lenders are financially invested in your house. Because the property acts as collateral against the loan, they have a right to take possession if you are unable to make payments. Unpaid taxes, however, can result in the government taking possession of the property, which leaves the bank empty handed.
Therefore, they collect additional funds as part of the monthly payment and pay the taxes themselves. This essentially guarantees that the taxes are paid and the bank’s investment is protected.
Most lenders require that you maintain some form of property insurance as a condition of the loan. (Even if it’s not required, home insurance is a good idea.) This insurance covers you financially if there is damage from fire, lighting, fallen trees, floods, and other causes. Each policy is different, and you may need special insurance in addition to your general policy. For example, you may need flood insurance or hurricane insurance depending on where you live.
This amount can vary widely because it is impacted by so many different factors. Your home’s value, where you live, and your proximity to a fire station, among many others, can change how much you’ll pay towards insurance.
There are numerous types of insurance, but all homes will need some from of general homeowners insurance. Depending on your loan, you may also need mortgage insurance, which is a different type entirely. This doesn’t support you in the event of home damage, but rather protects the lender if the borrower is unable to repay.
Note: Not All Mortgages Include Taxes and Insurance
Not all lenders and mortgage payments require taxes and insurance. Some lenders do not require that you pay these as part of your monthly payment, and instead allow you to make payments directly to the insurance company or to the government. If this is the case, your mortgage would only consist of principal and interest.
Even if they are not part of the mortgage payment, most lenders will take taxes and insurance into consideration when calculating your total costs of homeownership. Therefore, they can still impact your chances of landing the loan.
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