Many people dream of owning their own home, but the high cost of homes generally requires a home mortgage to make this become a reality. In today’s blog, we’ll review some basic terms and concepts related to mortgages.
A mortgage is a loan you obtain to pay for a home. The home is used for collateral on the loan, which means that if you don’t make your payments, the lender can take (a.k.a. repossess) the home away to cover your missed payments.
The loan principal is the amount you actually borrow to purchase the home. Interest is the amount the bank charges you to use their money; it is a percentage based on current economic indicators.
Because the loan is for such a high amount, it is usually financed for between fifteen and thirty years. The amount of time is called the loan’s term. Principal and interest together comprise most of your payment. The total is then divided into equal payments over the life of the loan using a process called amortization. With amortization your payments mostly go toward interest early in the loan and then more goes toward the principal later in the life of the loan.
For example, if you borrow $100,000 dollars with a 30-year loan at 7% interest, amortization will calculate your payments something like this:
|At 5 years||$665||$550||$115||$94,132|
|At 10 years||$665||$501||$164||$85,812|
|At 20 years||$665||$336||$329||$57,300|
In this example, after thirty years you would have paid off the $100,000 you originally borrowed, but you also would have paid an additional $139,509 in interest.
Your total payment is more than just the principal and interest. The acronym PITI can help you remember all the parts of your payment. It stands for principal, interest, taxes, and insurance. If you put less than twenty percent down on the loan, the bank considers it a little riskier and requires an escrow account. They pay your annual insurance and taxes from this account and collect money monthly to gather the required amounts.
If you are approved for your loan but are putting less than 20% down on the purchase, your lender will probably also require you to include private mortgage insurance (PMI) on your loan. The policy actually protects the lender in case of default, but the premiums for the coverage are paid for by the borrower. An additional amount is added into your PITI payment to account for PMI. Generally, when you have accrued 20% equity in your home, you may request to have PMI removed from your loan.
“The American Dream” homebuyer series on YouTube
GreenPath recently premiered its six-part homebuying series “The American Dream” on its YouTube page. From selecting the right realtor to learning how mortgages are obtained, the series can help homebuyers arm themselves with the important questions they will need to ask before they buy a home. Log on to http://www.youtube.com/greenpathdebt to watch the series.