Before you start applying for home loans, it’s important to understand exactly what a monthly mortgage payment consists of. You can also use an online mortgage calculator to determine how much your monthly payments will be.
What is PITI?
PITI is an acronym that stands for each of the 4 major components that make up your monthly mortgage payment:
When you make a monthly mortgage payment, you are repaying the principal and the interest to your lender. Taxes and insurance are secondary expenses that may also impact your monthly payments (depending on your particular loan agreement).
The term “principal” refers to the actual amount of money you are borrowing. The principal is the original size of the loan, which may or may not include certain other costs/fees.
If you’re approved for a $150,000 mortgage, you will owe the mortgage lender $150,000 in principal. You will also be charged interest on that principal. How much interest you owe will depend on the amount of the principal, your strength as a borrower, as well as the type of loan and the length of the loan.
Each payment towards principal adds equity to your home. However, building that equity takes time because most of your early payments go towards interest instead (a concept known as “amortization”).
The term “interest” refers to the financial expense for using the lenders money. Interest is charged by your lender alongside your monthly principal repayment.
Depending on the type of mortgage you obtain, it may or may not have fluctuating interest rates. A fixed-rate mortgage will have a steady interest rate throughout the life of the loan. Adjustable-rate mortgages (ARMs) have interest rates that change after specified periods of time, meaning your monthly payments will also change.
Longer loans (e.g., 30-year fixed-rate mortgage) will have lower monthly payments, but you’ll wind up paying more interest in the end. Shorter loans (e.g., 15-year fixed-rate mortgage) will have higher monthly payments, but you will save money on interest because you’ll be repaying the principal much faster.
Amortization ― Each month, as you repay your loan, part of your payment goes towards the principal balance (the total amount you borrowed to buy the house) and part of it goes towards the interest charged by the lender. In the beginning, the majority of each monthly payment is applied to the interest you owe ― during the life of the loan, the portion of each payment that’s applied to the interest decreases. In other words, the amount you pay towards interest is highest on your first payment and lowest on your last payment. Conversely, the amount you pay towards principal is lowest on your first payment and highest on your last payment. This method of repayment is known as “amortization.”
Taxes and insurance are also considered part of your monthly housing expenses. The lender may require you to deposit money into an escrow account to ensure payment of these items, though some borrowers may choose to pay the taxes and insurance on their own instead.
“Taxes” refers to real estate taxes, otherwise known as property taxes. In general, all residential real estate is subject to taxation. Property tax is an “ad valorem” tax, meaning that property is taxed “according to value.” Most property taxes are imposed locally (by counties, cities, or other districts) on a bi-annual basis. You can ask your real estate agent or contact the local government office for the tax rates that apply to your area.
Mortgage insurance protects the lender in case you fail to make the mortgage payments. If your down payment is less than 20% of the home’s purchase price, you will be required to purchase mortgage insurance. It usually costs about 0.5% of the total loan amount, which is added to your mortgage payments for the year. (The alternative is to take out a second loan, a.k.a. piggyback loan, to bring the first mortgage down to 80% of the purchase price.) A loan may be insured through the government or through the private sector (i.e., private mortgage insurance, or PMI).
In order to get a mortgage, you must insure the property. You can ask an insurance company or agent for an estimate. Note that some areas have special requirements for hazard insurance (e.g., floods, earthquakes and wind).
Most lenders will require you to deposit money into an escrow account. An escrow account helps ensure payment of the taxes and insurance associated with your mortgage loan. The lender collects the funds for taxes and insurance (from your monthly payments) and holds them in escrow until they are due.
You can use a mortgage calculator determine how much your monthly mortgage payments will be, as well as the total amount you will eventually pay for your house.