If you're already a homeowner, chances are you're familiar with the components of your monthly payment to your lender. If you have yet to make the leap into homeownership, you may not understand what this monthly payment includes.
Breaking down PITI
There are generally four components that go into the computation of your monthly payment: principal, interest, taxes, and insurance; collectively referred to as PITI.
Principal is the amount you originally borrow. Payments in the first years of the majority of loans go mostly toward the interest - only a small amount per month actually goes to pay down the principal; the payments in the final years consist primarily of principal repayment.
Interest is money the lender earns by taking the risk to loan you money. The interest rate on your loan has a direct correlation to the size of your payment. That is, a higher interest rate leads to higher monthly payments. For most homebuyers, higher interest rates reduce the amount of money they can borrow, and lower interest rates increase it.
Property taxes can account for a significant amount of your monthly payment. These taxes for local schools, city and county services, and other local entities are based on the tax rate for each of those taxing authorities and the appraised value of your property.
Instead of a large tax bill coming due at the end of the year, many people pay their property tax as part of their monthly payment. The annual amount is divided by the total number of payments in a given year. The lender collects these payments and holds them until they are due, at which point, the lender uses the money to pay the bill.
There are two types of insurance coverage that may be included in your monthly payment. The first type, property insurance, protects your home and possessions from fire, theft and other events your policy outlines.
The second type of insurance is private mortgage insurance (PMI). When a homebuyer does not put down at least 20 percent on the home, most lenders require PMI. PMI offers the lender some protection in the event the borrower is unable to repay the loan. PMI coverage can be dropped once you attain 20 percent equity in the home.
Taking responsibility for taxes and insurance
While these four components make up a typical monthly payment, some lenders will allow homeowners to pay taxes and insurance on their own. In this scenario, you'll have a lower monthly payment, but you must make sure you have the money available to pay property taxes and insurance when those bills come due. This requires discipline.
There are other strategies and products, as well, and your situation may indeed call for something a little different. A lender can sit with you and explain your options.
Amortization breaks it out
An amortization schedule shows how much of your monthly loan payment is being applied toward interest costs and how much to reduce the outstanding balance of your loan. At first, most mortgages consist primarily of interest payments, but the percentage applied toward principal and interest reverse over time. The amortization chart details the month-by-month progression of your mortgage.
In the end
When you buy a home, it's important that you understand the components and structure of your payments. These factors determine how long it will take you to pay off the mortgage and how expensive it will be own your home. PITI makes up a significant part of those costs, but there are other financial responsibilities to consider, like maintenance and repairs.
Your Realtor can be a great resource if you have questions about mortgages and other costs of homeownership.
Whether you're interested in buying your first home, your next home, or just want to know more about home-ownership in general, I encourage you to check out a couple of great online resources: http://www.texasrealestate.com/ or http://www.har.com/ and for all of your Pearland TX and Northern Brazoria and Galveston County real estate needs, please visit my site at http://www.danfrankrealty.com/. All of these sites offer tons of useful, real estate-related information geared specifically for Texans.
Danny Frank is a local Pearland TX Real Estate expert
This column was published in the 25Jan09 edition of the Galveston County Daily News