Financing a home means you are signing up to pay a monthly mortgage payment for many years, however, many first-time home buyers don’t fully understand what a mortgage payment entails. It’s not just the cost of the home parceled out over months and years. In fact, your monthly mortgage payment is made up of four main parts: the Principal, the Interest, the Taxes and the Insurance, altogether known as PITI. Read on to learn more about the pieces of your mortgage payment so you can make the best financial decisions for you.
Principal
The principal is what most people think of when they think about a mortgage payment—it’s the money that you are paying toward what you owe the bank for the home. The principal payment goes toward gradually paying down the balance that you owe. When you first purchase your home, the part of your mortgage payment that goes toward the principal is relatively small. However, over the life of your loan, the amount of your payment that goes toward the balance due grows. As long as you have a fixed-rate mortgage, your actual monthly payment stays the same.
Interest
The second part of your mortgage payment is the interest that you are paying on your mortgage loan. This amount is based on the interest rate that you secure with your lender prior to closing on the home. Initially, the interest portion of your mortgage payment will be quite high, but it will go down over time as you owe less and less on the loan. In general, as you continue to pay down your mortgage year after year, the amount spent on interest each month decreases as the amount spent on your principal balance increases. This can change, however, if you have an adjustable-rate mortgage.
Taxes
Property taxes aren’t something many home buyers consider when they purchase the home, but many lenders build in the cost of property taxes for their clients into the mortgage payment. Each month, your lender charges you the annual amount of your property taxes divided by 12. At the end of the year, the amount that you need to pay for your property taxes is in an escrow account held by your lender. When your tax bill comes due, in many cases, your lender will pay the property taxes directly from this account. The monthly amount that you pay toward taxes can fluctuate up and down over the years even if you have a fixed-rate mortgage simply because the cost of your property taxes can change.
Insurance
You wouldn’t drive your car without having it insured, and your lender won’t finance your home without it being insured by homeowners’ insurance! The cost of insurance is the fourth and final part of your mortgage payment, and is collected by your lender to be paid to the insurance company to protect your home against property damage and loss. In addition to homeowners’ insurance, your mortgage payment may also include private mortgage insurance, or PMI, which is an insurance policy you pay to protect your lender should you default, usually applied when a down payment of less than 20 percent is made. The good news is, private mortgage insurance isn’t forever, and is usually dropped from your monthly mortgage payment once you reach 20 percent equity in your home.
Being educated about mortgage payments is just one part of being prepared for home ownership. The NC Housing Finance Agency offers affordable mortgage products and learning resources for first-time and move-up buyers in North Carolina. Learn the basics of buying a home and more about how the NC Housing Finance Agency may be able to help make it more affordable for you at www.nchfa.com/home-buyers.
