Mortgage components – PITI

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When you make a monthly mortgage payment, it’s typically divided into four main components: principal, interest, taxes, and insurance. Here’s a breakdown of each:

1. Principal: This is the amount of money borrowed to purchase your home. A portion of your monthly payment reduces this loan balance. Early in your mortgage, a smaller portion of your payment goes towards principal. Over time, this amount increases as more of your payment is directed towards the principal rather than interest.
2. Interest: This is the cost of borrowing money from your lender. Your mortgage’s interest rate determines how much interest you pay each month. Initially, a larger portion of your payment goes towards interest. As you pay down your principal, the interest portion decreases.
3. Taxes: Local governments assess property taxes based on your home’s value. These taxes fund public services like schools, roads, and emergency services. Lenders often collect 1/12th of your annual property tax bill each month and hold it in an escrow account. They then pay the tax bill when it comes due.
4. Insurance: Homeowners insurance protects your property and the lender’s interest in the property in case of damage or loss due to events like fire, theft, or natural disasters. Similar to property taxes, lenders often collect 1/12th of your annual insurance premium each month and hold it in an escrow account to pay the insurance bill.

DID YOU KNOW?

Some lenders allow borrowers to opt out of having taxes and insurance included in their monthly mortgage payment. This means the borrower would be responsible for paying these expenses directly rather than through an escrow account. However, lenders typically charge a fee for this option. Here’s why:

1. Risk Mitigation: By including taxes and insurance in your monthly payment, lenders reduce the risk that these important payments will be missed. Unpaid property taxes can lead to liens against the property, and lapses in insurance coverage can leave the property unprotected.
2. Administrative Costs: Managing escrow accounts involves administrative work for the lender. By charging a fee to opt out, lenders compensate for the additional risk and administrative burden of not managing these payments.

Borrowers who opt out need to be diligent about making their tax and insurance payments on time to avoid penalties or lapses in coverage.