Individuals and families typically do not have enough money to pay cash for a home, so they rely on a loan. A loan used to buy a home is called a mortgage. Applying for a mortgage is more complicated than applying for a credit card or getting a loan for a car. It’s important to understand how a mortgage works, how to get the best mortgage for your situation and what you can do to prepare yourself for the financial obligations of owning a home.
A mortgage is a loan obtained to purchase real estate. The mortgage is a lien (a legal claim) on the home or property that secures the promise to pay the debt. If you do not pay your mortgage payments, the lender can take your home from you. By foreclosing on the mortgage, the lender can resell the home in order to recoup the money loaned to you.
What is included in a mortgage payment?
Most mortgage payments include: principal, interest, real estate taxes and homeowners insurance. Lenders often call this a PITI payment.
- Principal – The principal is the part of the mortgage payment that is applied to the original amount borrowed.
- Interest – The interest is the amount the lender charges for lending the money.
- Taxes – The taxes portion of the payment includes the property taxes that the lender collects from the borrower and pays to city and county government for the property.
- Insurance – A lender will require that you maintain homeowners insurance on your home in the event of property loss or damage.
The lender will deposit the tax and insurance portions of your payment into an escrow account. An escrow account is a special account held by the lender and used only for the payment of taxes and insurance related to a specific property. When the yearly property tax and insurance bills are due, the lender simply deducts the correct amount from your escrow account and pays the bill.
What are the factors that influence the amount of a mortgage payment?
- Size of down payment
- Amount of mortgage
- Mortgage interest rate
- Repayment term
- Cost of mortgage insurance
- Amount of property taxes
- Amount of annual homeowners insurance premium
What is amortization?
Over time, you will repay your mortgage gradually through regular, monthly payments of principal and interest. The amounts of these payments are calculated to let you own your home debt-free at the end of a fixed period of time.
During the first few years, most of your payments will be applied toward the interest you owe. During the final years of your loan, your payment amounts will be applied mainly to the remaining principal. This type of repayment method is called amortization. If you sell your home prior to the end of the loan, you will be required to pay back the remaining principal balance due on your mortgage loan to your lender.