A mortgage payment is typically made up of several components, often referred to by the acronym “PITI,” which stands for Principal, Interest, Taxes, and Insurance. Here’s a breakdown of these components:
- Principal: This portion of the payment goes directly towards reducing the outstanding balance of the loan. Early in the loan term, the principal portion of each payment is small, but it increases over time as the loan balance decreases.
- Interest: This is the cost of borrowing money, calculated as a percentage of the outstanding loan balance. In the early years of a mortgage, the interest portion of each payment constitutes the majority of the payment. As the loan balance decreases over time, the interest portion decreases while the principal portion increases.
- Taxes: Property taxes charged by local governments are often included in mortgage payments. Lenders collect these taxes as part of the mortgage payment and hold them in an escrow account (also known as an impound account in some regions) to pay the property taxes when they are due.
- Insurance:
- Homeowners Insurance: This insurance covers damage to the property and losses from theft, fire, and other liabilities. Like property taxes, homeowners insurance premiums can be collected with each mortgage payment and held in escrow until the insurance bill is due.
- Private Mortgage Insurance (PMI): If the down payment on the home was less than 20%, lenders usually require PMI. This insurance protects the lender in case the borrower defaults on the loan. PMI can be a significant part of the mortgage payment but can be removed once the homeowner has enough equity in the home.
- Homeowners Association (HOA) Fees: In some cases, if the property is part of a homeowners association, monthly or yearly HOA fees might be included in the mortgage payment. These fees cover the costs of maintaining common areas, amenities, and sometimes certain utilities or services.
The exact components of a mortgage payment can vary depending on the type of loan, the lender, and specific arrangements made during the mortgage negotiation. Not all mortgages include escrow for taxes and insurance, so in those cases, homeowners must pay those bills separately from their mortgage payment.
