A typical monthly mortgage payment includes different components. Some people are unaware of what these components are (or why they are included). The total mortgage payment is sometimes called the “PITI” Payment. “PITI” is an acronym which stands for Principal, Interest, Taxes & Insurance.
Principal & Interest
Principal & Interest is sometimes called the “Loan Payment” because this is the amount that goes towards paying off your loan. Principal is the amount of your payment that reduces your loan balance each month. Interest is the amount of interest that has accrued on your mortgage during that month. In a standard fully amortizing fixed rate loan, the amount of Principal vs Interest will change as the loan progresses. At the beginning of the loan you will pay more interest than principal – as the principal is paid down, less interest is able to accrue so more and more Principal will be paid off each month. While the ratio of Principal vs Interest will change every month, in a standard fully amortizing fixed rate loan the total amount of Principal & Interest will be the same from start to finish.
Escrows are held by the lender to pay bills on your behalf. Each month you deposit one month’s worth of these bills into an escrow account, so little by little you stock that account which gives your lender enough money in the account to pay those bills. If you put down 20% or more, or have 20% in equity you may elect to not have the lender pay these bills on your behalf. What bills can a lender collect for? Most typically – Property Taxes & Insurance
Property Taxes are the “T” in “PITI”. Your local jurisdictions tax the property based upon an assessed value of the property and tax rates that those jurisdictions determine (not the lender). When those taxes come due, the lender pays those taxes on your behalf.
Insurance is the “I” in “PITI”. This could be two different types of insurance. Commonly, they will collect for Hazard or Homeowner’s Insurance. This is the insurance that protects you & the lender in case of any type of destruction of the property. If you have a loan on the house, the lender will almost assuredly require that you have homeowner’s insurance on the property to protect their investment.
You might also include PMI or Private Mortgage Insurance, or it may just be called MI. This is insurance that protects the Lender when a borrower puts less than a 20% down payment on the property. Since the majority of the risk is held with the lender, a policy is put in place that protects the Lender in case you default on your loan before reaching a significant amount of equity in the property.