If you are steadily moving towards buying a home and ready to approach a lender, take a moment to recognize the four components of a monthly mortgage payment – Principal, Interest, Taxes, and Insurance (PITI). This is your greatest expense as a homeowner, and it is important that you be aware of these financial commitments before you own your home so that you can comfortably budget and afford a dream home that is within your price range. Moreover, by reviewing and understanding the dynamics of each financial unit, you may be able to acquire bigger loans with fewer drawbacks.
Principal (P)
Principal is the total value of the loan you borrow from the lender, minus the interest. At the onset of paying off your mortgage, the principal component of each monthly fee will be small, eclipsed by the interest component; but, as time passes, and you acquire more equity with each portion of the loan reimbursed, the final stretch of your mortgage term will be largely composed of principal installments.
Interest (I)
Interest is an expense the lender charges you for the privilege to borrow a loan. The interest rate directly influences the size of your loan; higher rates turn out smaller loans, and lower rates gift you with the concession to borrow greater mortgage amounts. A lender determines the rate of interest by weighing a combined analysis of your credit score and down payment in relation to the loan term and loan-to-value (LTV) ratio.
Your credit score is a three-digit number ranging from 300 to 850 that can be discovered by examining your credit report, which provides a detailed account of your credit history, including past and present cases of debt, bankruptcy, liens, civil judgements, and collections. A credit score of 700 or higher grants you a lower rate of interest. Visit Annual Credit Report to receive a free copy of your credit report today.
The initial payment you put towards a home’s purchase price is called a down payment, and if you invest a significant amount of monetary appreciation in your new home, you are allotted a lower interest rate and a greater percentage of equity.
When you and the lender write-up a loan agreement, the loan term is a designated period of time in which you have to pay off the mortgage. Homebuyers favor 30-year contracts due to the follow-on of smaller monthly payments; however, 15-year mortgages typically have lower interest rates attributed to them, as lenders associate a lower level of risk with a client who promises to make good on what they owe in a shorter time span. Universal American Mortgage Company (UAMC), a member of Lennar, offers fixed- and adjustable-rate mortgages on both 15- and 30-year loan types.
To assess the level of risk pertaining to the approval of a client’s loan request, lenders calculate the loan-to-value (LTV) ratio. This quotient is found by dividing the principal component of the mortgage payment by your home’s appraised value and multiplying the answer by 100. An example: If your new home has an appreciated worth of $210,000, and the loan you borrow is $100,000, the LTV ratio (100,000/210,000) is 48%. High LTV ratios lead lenders to impose higher interest rates because the probability of a loss on their loan is a statistically higher risk. If a homebuyer is saddled with a loan that has a high LTV ratio, it is typically required that they purchase private mortgage insurance (PMI).
Taxes (T)
Taxes refer to real estate or property taxes, which are typically gauged by local or municipal governing bodies based upon the value of the estate; these levies finance public institutions and services, such as the police and fire departments, the school districts, garbage collection, road repairs, and snow removal, to sustain and improve the livability of an area. Property taxes adjust annually, factoring in the current market value of your home, and differ by location (i.e., county and state). Contact the office of the county assessor or recorder for a report of a home’s property value and subsequent taxes, or find this information online at Property Shark.
You can pay your taxes through your loan officer by setting up an escrow account. Each month, the lender collects funds from your periodic mortgage payments to put in escrow; these reserves remain untouched till taxes are due. Acting as a third party agent on your behalf, your loan officer pays the mandates where they are due, assuming responsibility for any late-paid tariffs. The portion of your monthly mortgage payment that is apportioned to tax obligations equals one-twelfth of the yearly tax amount.
Insurance (I)
Insurance pertains to property insurance and private mortgage insurance (PMI). Property insurance includes the subsidiary policies of homeowners insurance and hazard insurance. Homeowners insurance serves you in the event your home or personal belongings therein receive damages, and simultaneously protects you from liability if someone or their property is impaired at your estate. Two types of homeowners insurance are available to you: (1) Replacement-cost, which reimburses you the actual cost for repairs and/or replacement of personal property, and (2) cash-value, which only refunds you the post-depreciated market value. Visit North American Advantage Insurance Services, a member of Lennar, for a free insurance quote today, and let an insurance agent pre-evaluate and rate your home to assess your personal insurance needs.
Purchasing hazard insurance is a necessary, sometimes even mandatory investment to procure if your home is located in an area prone to natural disasters. Any place that is characteristically affected by floods, earthquakes, or fires, stirs lenders with discomfort, as the loss or damage of your home prior to the full return of their loan translates into a lost investment for the mortgage firm; therefore, lenders will require you obtain the subject-specific hazard insurance. Unknown to most homeowners though, hazard insurance only compensates you for wreckage to a home’s structure; it does not reimburse you for lost possessions or bodily injury resultant of a natural event.
If you do not obtain 20% or more equity with your down payment, resulting in a high LTV ratio – exceeding 80%, most loan officers require you secure PMI, as it protects the lending firm in case you, their client, defaults (i.e., fails to pay the principal or interest installments of a loan). PMI fees are contingent on a borrower’s loan term, down payment, and credit score, composing 0.25% to 2% of the mortgage balance each year; the rate will be great if you accept a heavy loan that is recognized with a high calculable risk factor. PMI agreements can be broken once you acquire 25% equity in two to five years; after the five-year lapse, 20% is sufficient.
The insurance component(s) of your monthly mortgage payments can be paid off with your tax responsibilities using the escrow account. Once more, your loan officer will take escrow funds from your monthly dues that are approximately one-twelfth the yearly cost of your insurance and be held accountable for seeing the respective insurance providers get their money on time.
Sources:
Mortgage Guide: Adjustable-Rate Mortgage Loans Explained
Tax Policy Briefing Book – State and Local Tax
2016’s Property Taxes by State
Can I get rid of a mortgage escrow account?
4 Things to Known When Buying Homeowners Insurance
