If you’re not a homeowner, you might be confused by all the media coverage and conversation surrounding loan defaults and foreclosures. If you're thinking of buying a home, you should take the time to learn more by understanding the basic terms used to describe a mortgage.
A mortgage is a loan to finance your purchase, and uses the home as your collateral, which the lender can take back if you don't pay your debt. That debt is usually paid monthly, and payments include Principal, Interest, Taxes and Insurance, commonly referred to as "PITI."
Principal is the sum you borrow, reduced by how much money you put in as your down payment. Interest, as a percentage rate, is what the lender charges as a fee to use the money you've borrowed. These two items make up most of your payment. "Amortization" over the life of the loan makes the first several years of your payments mostly interest, while later payments mostly apply to principal. Typically, a shorter term on your loan increases your payments slightly, but allows you to pay off your principal much quicker. Today, interest rates are at historic lows, so it's a great time to make a purchase.
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Taxes are the local levies, based on the value of your home, used to fund schools, roads, and other services in your community, such as Monrovia's Wilderness Preserve tax and Measure M for our schools, both of which were passed by taxpayers. These are paid directly by you or by your lender on your behalf from funds held in an escrow account. The tax year runs from July 1 through June 30, and you pay your tax bill in two installments, due in April and November.
Insurance is required by the lender to protect your home against loss and damage. Your homeowners insurance is something you choose on your own and is paid directly to your insurance provider on an annual basis, however your lender will consider the price of your policy into your monthly payment for qualifying purposes. Sometimes lenders will offer buyers the option to purchase insurance directly from them, but most people feel better making that choice for themselves. Private Mortgage Insurance, also known as "PMI," protects the lender against riskier loans, and many buyers couldn't afford to buy a home without it. Any time a buyer puts down less than 20%, the PMI will be mandatory.
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Many lenders offer you the opportunity to increase your interest rate to cover the PMI in your loan payment. This also allows you to write off the PMI on your annual taxes instead of making a separate PMI payment, which is not tax dedutible. Buyers should consult with both their lender and their tax accountant to determine which choice is best for them.
Thus begins your education toward a smart and secure home purchase!
