The Components Of Your Monthly Mortgage Payment
Each month when you write out that hefty mortgage check, you might be surprised to learn that you are paying for more than just for your house.
Included in each payment is PITI, which stands for Principal, Interest, Taxes and Insurance. Let’s examine each of these payment "components", as well as other charges you might not know you are paying.
- Principal and Interest (P&I) is the part of the payment that’s amortized over a specified number of years in order to pay off the loan amount (principal) and the interest that accrues each month on the loan. For most traditional mortgages, with each passing month the interest portion of the P&I decreases and the principal portion increases until the loan is fully paid off.
- One-twelfth of the annual real estate taxes are escrowed each month. Nearly all lenders escrow taxes because unpaid taxes take a superior lien position to any mortgage. If the owner does not pay their property tax, the local government has authority and power to sell the property in order to collect delinquent taxes. For example, if the property owner owes $3,000 in taxes and $100,000 on the mortgage, the government is only concerned with the unpaid tax debt. If the property is valued at $200,000 and is sold for $3,000 in unpaid taxes, the lender has lost $100,000. Escrowing taxes each month is the lender’s safeguard against the possibility that the mortgage lien position could be jeopardized by nonpayment of taxes.
- One-twelfth of the annual homeowner’s insurance premium (I) is also included in the monthly mortgage payment. By mandating that the homeowner carry insurance, the lender is covered if the home is damaged or destroyed and the homeowner is unable to pay for necessary repairs. Some states prohibit the lender from forcing the borrower to insure the dwelling for more than the outstanding balance of the loan. However, having only enough coverage to pay off the mortgage addresses only the lender’s interest in the dwelling, not the homeowner’s. Coverage for other occurrences, such as theft and liability, should also be considered. Most insurance companies offer a full replacement-cost rider, which adjusts coverage to protect the full value of the dwelling.
- Most lenders require that the insurance policy be paid in full for the first year at the time the loan closes. The lender then escrows one-twelfth of that premium in the monthly payment. This method assures that when the policy renewal date comes around for the next year, there are sufficient funds in escrow to pay the insurance for the following year. By doing this, the lender is protected if the owner forgets to pay the premium.
- Private Mortgage Insurance (PMI) covers the lender against the possibility of default and foreclosure on properties with an 80% or greater loan-to-value (LTV) ratio. PMI is not required when a borrower purchases property with a down payment of 20% or more.
- Each month, a homeowner may also be paying one-twelfth of a housing development’s mandatory annual homeowner’s association or maintenance fees (HOA). The lender typically does not escrow these charges, rather the fees are considered as part of the borrower’s monthly or annual housing expense. Therefore, they are included in the qualifying process.
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