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Must-know mortgage terms: set yourself up for success
How does interest work? What does escrow even mean? What kind of homeowners insurance is best? When it comes to mortgages, there are probably tons of questions you want the answers to before you make any big decisions (or sign those contracts). Don’t know where to start? Check out these key terms and get an inside look at what mortgages are made of. Your future homeowning self will thank you later.
“PITI” payment: breaking down mortgage costs
When shopping for a mortgage, you’re going to want to know how much money to set aside each month and where it’s going to go. And there’s good news—there’s a helpful acronym to help you sort it all out. Your mortgage is often called your “PITI payment.” That’s because it normally includes Principal, Interest, Taxes and Insurance. Let’s break it down some more.
This is the full amount you will borrow and owe on your loan (without interest factored in). The larger the down payment you make, the smaller your principal amount will be—and you'll reduce your outstanding principal over time just by making your monthly mortgage payments.
This is the money paid to the lender for the use of the loan funds. It’s calculated as a percentage of your principal, and it’s also paid off over time. So, there’s no need to worry about tackling a large fee at once. Making additional principal payments can reduce the amount of interest you pay over the life of your loan. Plus, you may be able to refinance and save yourself some interest money down the line, so it’s always good to consider your future mortgage options. Looking for a little extra guidance? Check out the Consumer Financial Protection Bureau (CFPB) website for tools that can help you calculate your interest and other handy homebuying resources.
When it comes to your PITI payment, there’s another added bonus to make your life a little easier—you don’t have to sweat the tax details. You'll have help keeping track of tax payments due because they’re typically included as part of your PITI mortgage payment.
Plus, it’s good to stay informed and know exactly where your money's headed. Things like property, local, county and city taxes can all be calculated into your PITI mortgage payment.
You’re going to want to protect your home, and lenders are going to want to protect their collateral (i.e., they’ll want security for the loan they’re giving you). That’s where insurance comes into play, and there are two main types.
Homeowners Insurance: This is typically a requirement if you take out a loan to buy your home and is based on the value of your property. It covers you for natural disasters, break-ins, property damage, liabilities and more, which means you’ll want to keep an insurance policy even after you pay off your mortgage.
Rates and terms vary, so make sure to do your research before selecting an insurance policy.
Mortgage Insurance (MI): Required by some lenders and often mandatory when you make a down payment of less than 20%, this protects the lender in case you can’t make your payments. Depending on your lender and the specific mortgage product you obtain, MI may be paid in full or in part by you or on your behalf by the lender.
Amortization: your next step in the process
Moving on from PITI brings us to amortization. Big word, but amortization is simply the part of the mortgage process that involves making monthly payments to get your mortgage to a zero balance. That just means if you have a 30-year mortgage, for instance, your amortization period is 30 years. Not so hard to remember, right?
One more thing to keep in mind about amortization: Interest is determined based on the principal balance when you first get that loan. As you’re paying off your mortgage, the balance gets smaller—and as it gets smaller, so does the interest part of your payment. In other words, you’ll pay less in interest and more in principal as time goes on. Nice!
Escrow accounts vs. being “in escrow”
What's an escrow account and how's it work? Well, if your taxes and insurance are included in your mortgage, the portion of your monthly payment collected for your homeowner's insurance and property taxes are bundled into an interest-bearing holding or escrow account, then are paid by your lender when they’re due. Think of it like an old roomie collecting everyone’s rent before paying the landlord.
You can also be “in escrow,” also known as making an earnest money deposit when you sign a purchase and sale agreement, which involves the use of a deposit account until the deal is closed and you officially own your home. It serves as a neutral space for your funds. Think of it like a virtual safe that keeps you and your investment protected. Simply stated, an escrow account is where certain parts of your mortgage payment are held. Being "in escrow" is unrelated to the mortgage, is temporary and happens while you’re in the homebuying process.
So, that's the skinny on mortgages and buying a home, but there’s lots more to learn if you want to take a deeper dive. Visit the Learning Center for more insights, and you’ll soon be ready to sign for your very own mortgage.
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This article is based on information available in February 2022. It is for general informational purposes only. It is not intended to provide specific financial, investment, tax, legal, accounting, or other advice and should not be acted or relied upon without the advice of a professional advisor. A professional advisor will recommend action based on your personal circumstances and the most recent information available.