Breaking Down a Typical Mortgage Payment
What makes up a mortgage payment can become complicated, regardless of whether you are a new or seasoned homeowner. It’s okay if you just want to know the monthly amount you owe and not delve too deep into the financial concepts. For those of you who want a few more details, it’s important to understand exactly how mortgage loans breakdown as a consumer.
If you've ever heard your loan officer mention something called a "pity payment" and scratched your head trying to figure out where the need for "pity" came into the equation, you're not alone. What they were really saying was "PITI," and they were talking about Principal, Interest, Taxes and Insurance, which are the four main components that make up a typical monthly mortgage payment.
While PITI is the typical, and commonly assumed makeup of a mortgage payment, some loan programs could include other elements. Based on your property and loan type, your monthly payment may also include mortgage insurance. For the most part, though, PITI is what you'll be looking at when planning your mortgage and the monthly payments to come.
Let's take a look at a typical PITI monthly payment breakdown:
PRINCIPAL: The principal is the amount that pays back and reduces the mortgage loan balance. As time passes, the amount you pay in principal each month will increase as the interest amount decreases.
INTEREST: Interest is the ongoing cost of borrowing the money in a mortgage loan. As time passes, the amount you pay in interest each month will decrease while the principal amount increases.
TAXES: Real estate or property tax amounts are decided through your property assessment. The taxes due for your property will be the same amount regardless of the size of your mortgage. The tax portion of your mortgage payment is typically held in an escrow account that makes sure your taxes are paid on time.
INSURANCE: Homeowners or hazard insurance amounts are decided by the coverage plan you choose with your insurance company. This part of the mortgage payment is not affected by the size of your mortgage. Insurance payments are typically held in an escrow account that makes sure your insurance is paid on time. Some loan programs also have mortgage insurance, which is affected by the size of your mortgage. Mortgage insurance is insurance for the lender, should you default on (stop paying) your debt obligation.
For more information, check out this article.
Things to Know
There are other calculations and fees that will impact your monthly amount due when figuring out your mortgage and the financial responsibilities it requires.
Loan Amortization Calculator
This is referred to above in the principal and interest section. Over time the mortgage loan is amortized, which means the mortgage debt is gradually reduced over the loan term, taking interest into account. Each month your mortgage payment has a portion that goes toward principal and a portion towards interest. In the beginning most of your payment is going towards your interest and when you are reaching the end of your mortgage, you will be paying more principal. You can plug in your numbers into this amortization calculator to see how your allocations change over time with regards to principal and interest.
Private mortgage insurance, also known as MI, is to ensure the lender is protected. No, 20% is not needed for a down payment on a home, but typically if your down payment is less than 20%, you will also need to get mortgage insurance. Although it does make homeownership within reach for some who do not have the 20%, it also increases your monthly payments. Mortgage insurance will be a percentage of your principal and is typically paid monthly, but there are other options. Take a more detailed look at MI here. (can link out to new one once published)
Homeowners Association Fees (HOA)
Although not part of your mortgage payment, it could be an added financial obligation, depending on where you decide to call home. An HOA fee is typically associated with a community. It will go toward any shared facilities and property ground maintenance. Depending on the size and quality of your community, this may add a substantial amount to your overall housing costs.
Why Understanding This is Important
It's good to understand how this all comes together when you're considering how much you can afford and, if hunting for a new home, where you want to search. For more peace of mind, read up on how you can plan for extra home expenses.
Imagine this scenario: You are pre-approved for a mortgage, the monthly payments are within your budget, and all you must do is find the perfect home. You find that home, go back to your loan officer, and find that the monthly payments suddenly jumped up past your comfort level. What happened? Is your loan officer playing tricks?
Not at all. If you had been paying attention to property taxes while you were doing your home search you may have noticed that the property taxes on this must-have home were significantly higher than what had been estimated. Loan officers generally make it their business to get those estimations as close to local averages as possible, but it can happen that a certain municipality happens to have a higher rate than the others around it. The same can happen with homeowners' insurance. Not all insurance companies have the same prices, and each property and situation will be just a little different. Your loan officer will do their best at estimating during your pre-qualification, but until you have those real numbers it's just a "best guess."
Bring Your Questions
It may seem like a lot to keep track of, but don’t let that deter you from finding your dream home in a price range you can afford. You'll be happy to know that you have allies. Your RMS Loan Officer should be able to help you with any questions you have and supply you with information that you can read over at your pace. If you're working with a real estate agent and an insurance agent, they should be valuable resources for your questions as well. All these professionals have made it their business to know this stuff inside and out, and they're there to help you. Bring your questions.
And now, knowing what you do, you can tackle this mortgage planning stuff with full awareness of how each of these pieces fit into your overall monthly payment picture. There's no need for pity here. Just some good old-fashioned self-confidence, knowing that you've got this.
What does PITI mean?
From FHA (Federal Housing Administration) to FRM (fixed-rate mortgage), and DTI (debt to income) to LTV (loan to value), the number of acronyms and abbreviations you encounter when house hunting may leave you shouting "SOS!" Here's another one you've probably come across: PITI. Shorthand for "Principal, Interest, Taxes and Insurance," the letters PITI represent the basic components of a typical monthly mortgage payment.
While the alphabet soup may sound confusing, don't worry. By breaking each down one by one, you may find it's as easy as learning your ABC's. Well, almost.
P is for Principal
The principal is the most basic, foundational component of a mortgage payment. It's the amount of money that you borrow to purchase a property, which you pay back in installments over an extended period. For example, on a 30-year FRM (there's that abbreviation again), you have 30 years to pay the principal amount back. Over time, with each payment you make, the principal diminishes, getting you one step closer to owning your home sweet home outright.
I is for Interest
When it comes to mortgages, interest runs part and parcel with principal. Interest is basically the amount of money that you pay in order to borrow a specific dollar figure. It's represented as a percentage, or more specifically, annual percentage rate (APR).
Where the P and the I coincide is in terms of what your monthly payment actually goes toward: the principal and/or the interest level. As time passes, the amount you pay in principal each month goes up slightly. Correspondingly, what you spend on the interest goes down. The two will eventually reverse positions with the principal taking up the lion’s share until both are paid off.
If you have an adjustable rate mortgage (ARM), the fluctuations could be more substantial with any rate changes.
T is for Taxes
The "T" in PITI refers specifically to real estate or property taxes. Everyone who owns a house is required by law to pay them to the municipality. Taxes fund various services or institutions that may include:
- Public schools
- Roads and bridges (upkeep, installation, construction, snow removal, etc.)
- Fire departments
- Police departments
To make paying property taxes easier and more convenient, a portion of your monthly payment goes toward this amount. So instead of saving up and submitting it every year, your lender will handle this process for you by setting up an escrow account. Generally speaking, the amount collected for property taxes is equal from month to month unless your tax bill changes.
It's important to be mindful that once you've paid your mortgage in full, you still have to pay property taxes. You may therefore want to set up an account to make regular contributions to it over time so you're not left scrambling when the property tax bill comes due. If you run the numbers and contribute consistently, you should be all set.
I is for Insurance
Last but certainly not least is insurance. In the residential real estate space, insurance can refer to one or all of the following:
- Homeowners or hazard insurance
- Flood insurance
- Mortgage insurance
Usually when you buy a home, homeowners or hazard insurance is required. But it's really an investment, as the proceeds can be used to help you get back on your feet should your home be damaged by things like fire. Depending on where your property is located, you may also need flood insurance or possibly hurricane insurance.
You may also be required to purchase mortgage insurance if your loan-to-value (LTV) is above a certain percentage. This is something that protects your lender in the event you're unable to repay your loan.
Long story short, the smallest portion of your monthly payment services insurance expenses. And, much like the "T," payments are usually held in an escrow account and the amount deducted is the same each time unless your premium changes. This is all designed to provide flexibility, consistency and simplicity.
PITI mortgage payments make budgeting easier to manage. If you have any questions about PITI — or any other homebuying issue, abbreviated or otherwise — Contact us at Residential Mortgage Services today.
What's the difference between interest rate and APR?
Even if you're not an expert in the real estate industry, you're probably aware of the various phrases that are synonymous with one another. Whether it's loan and mortgage, buyer and borrower or house and home, there are several terms that are similar in meaning.
Then there's annual percentage rate and interest rate. While there are undoubtedly similarities to both terminologies, their differences are noteworthy. It is important to understand how they contrast and compare. Whereas one is more straightforward in what it describes, the other is more all-encompassing.
For the sake of simplicity, let's start with the likenesses and then move on to what makes them distinct.
How they're alike
Annual percentage rate (APR) and interest rate are written out or described as a percentage. For example, 3.5%.
How they're different
Interest rate is related to the cost of borrowing the funds and one of the factors used to calculate the monthly payment of the mortgage loan. APR is more inclusive, meaning it takes other fees into account, in addition to the interest on the loan. As noted by the Consumer Financial Protection Bureau, these include:
APR’s are usually greater than interest rates because these fees are expressed as a cost over the life of the loan. As noted above, the monthly payment is based on the interest rate, not the APR.
Why are they important to know?
More than anything else, knowing and understanding the APR and interest rate is to increase understanding and transparency of the mortgage loan. It's important to go into any major purchase with your eyes wide open and being aware of both can help you with the decision-making process and how to best approach managing your expenses.
Disclosing the APR and the interest rate as separate and distinct is also the law, mandated by the appropriately named Federal Truth in Lending Act. The TILA authorizes lenders to make borrowers fully aware of these details.
Another reason why it's important to know is to help you avoid sticker shock. Think about any major purchase you've made; you've probably bought something that turned out to be more than initially advertised.
By including the APR into your calculations for how much you can expect to pay, you'll get a better sense of the rock-bottom price when everything is included, above and beyond the list price and the interest rate on the loan itself.
With these details out of the way, here are a few things to be mindful of when you're evaluating the APR and what you'll spend from month to month, as referenced by the CFPB:
APR has limitations
In addition to terms and phrases, the homebuying process is filled with choices, one of which is whether you select a fixed-rate mortgage or variable interest. If you choose the latter, it means that the interest on what you spend could change over the life of the loan, thus impacting how much you spend per month. Understand that APR can't predict the future, so the APR has its limitations when it comes to measuring how much you can expect to pay should interest rates fluctuate.
Compare apples to apples
Fixed-rate loans and adjustable-rate loans, while similar, are two different animals in terms of how they operate and are calculated. Therefore, comparing the APR of an ARM with the APR of a fixed-rate loan may be difficult to draw any broad-based conclusions, even if one is higher than the other. Instead, it's best to judge the APR when measured up against the same loan type (i.e. fixed to fixed, ARM to ARM).
The same goes for the APR of a closed-end loan and the APR of a home equity line of credit, or HELOC. Fees aren't included in the APR figure for the latter.
If you have any concerns or points of confusion about buying a home, please contact us at Residential Mortgage Services. The only silly question is the one that's unasked.
What is the difference between an appraisal and an assessment?
Real estate is filled with terms that are more-or-less synonymous. From mortgages to loans, houses to homes, or lawns to yards, the list of interchangeable words is rather lengthy.
Two other terms that seem one and the same are appraisal and assessment. Yet while these do share some similarities, their differences far surpass their parallels. Understanding how they're distinct - and, above all, why it even matters - can make you a more informed homeowner, potential seller or prospective buyer.
What is an assessment?
In many ways, an assessment is almost self-defining, in that every so often, municipalities assess the value of houses in a given area or community. They do this for one overarching purpose: to determine what homeowners will pay in property taxes, an expense for which every homeowner is responsible. Typically, among those who are still paying off their mortgages, property taxes are included as part of their monthly mortgage bill. Those who already own their house - meaning they've paid their mortgage in full - ideally set aside money each year so they have the funds to pay by the due date.
The property taxes that someone pays in any given year is ultimately determined by the assessment.
What is the assessment process like?
Perhaps the biggest distinction between an appraisal and an assessment is what they entail. Municipalities send out one or several tax assessors to go around the city and assign values to existing homes. They use a number of different variables - such as sales comparison data and cost method - to determine what a given property is worth.
One thing they don't do - at least not typically - is physically go inside the house to see how many rooms there are, what installations are in place and observe other physical aspects of what makes a house a home. Because of this, assessments may not adequately reflect a property's true value. The assessment is one step in the process conducted by the municipality to determine what homeowners pay in annual property taxes.
How often are assessments performed?
There is no hard and fast rule as to how often assessments occur. That is determined by the local tax assessor's office. But as The Balance reported, it generally occurs once every five years. Some municipalities do them more frequently (i.e. annually), others less (i.e. once every 10 years).
What is an appraisal?
An appraisal is a much more exhaustive evaluation process. Lenders typically require a professional appraisal to be done on the subject property whether for a purchase or a refinance transaction. Among the reasons include determining fair market value and loan-to-value. For a purchaser, this also helps to ensure you aren’t paying too much.
If there is one thing that has consistently increased in value, it's real estate. Every month, the National Association of Homeowners releases reports detailing how much the average single-family residence sells for in the U.S. As of May, the median has risen on a year-over-year basis for 98 months in a row. This fact alone speaks to the smart investment of homeownership.
An assessor only takes into consideration external factors like some of the ones mentioned above, a professional appraiser considers many unique aspects of a residence. These are a handful of them:
- Number of bedrooms
- Architectural style
- Square footage
- Construction materials used in installations (e.g. marble countertops, hardwood floors, etc).
- Window composition
- Age of house
- Roofing material
- When the roof was last installed or updated
- Insulation type
- Basement and whether it's finished
- Foundation (e.g. Concrete slab, crawl space, etc.)
And that’s just the beginning. While it’s not an exhaustive list, it gives a better sense of the many variables used by an appraiser when completing the Fannie Mae Uniform Residential Appraisal Report.
Who requests appraisals?
Generally speaking, mortgage lenders will request an appraisal to obtain a detailed understanding of the property based on overall condition, conformity to the area, and market value. The appraisal report is used to assist the lender in its lending decision.
Ideally, appraised values and assessed values would be identical. That's rarely the case, mainly because the processes involved in each are so different from one another. Whereas an assessment is an educated guess, an appraisal is an informed, comprehensive calculation.
As a prospective or current homeowner, ensure that you know both of these figures. If its assessed value is higher than its appraised, you may have a case for paying less in property taxes to your municipality.
For more information on any aspect of the homebuying process, contact us at Residential Mortgage Services. We'll guide you home.
Understanding the Mortgage Pathway
As a homeowner, you know that you have several ongoing responsibilities. High on the list is ensuring your humble abode is properly maintained - both inside and out - so it retains its value.
An additional major task is keeping up with your monthly mortgage payment. It's a regularly occurring errand that gets you one step closer to full-fledged ownership.
Once the check is in the mail, payments are out of sight, out of mind. But have you ever wondered where that check actually goes? One would naturally assume it goes to whoever made the loan in the first place, such as a bank or mortgage servicing company.
While this is in part true, the mortgage payment paper trail is much more involved and intricate than one and done. In short, just as there are many working parts to finding or buying a home, the same is true for paying off your home loan.
Let's examine how it all works on a step-by-step basis. It can help you get a better sense of some of the lesser-known aspects related to financing and the housing market from a dollars and cents perspective.
Mortgage servicer sends payment to GSE
As soon as your lender receives your monthly payment, the process is underway. This starts when the servicer takes out a small fee for the administration of the loan and escrow account, which is used to fund property taxes and hazard insurance.
What remains usually goes to one of three government-sponsored enterprises: Fannie Mae, Freddie Mac and Ginnie Mae. GSEs (government-sponsored enterprises) are financial services organizations that are chartered by the U.S. Congress and serve many different functions, such as oversight and enhancing the flow of credit and liquidity.
Were it not for these organizations, homeownership would likely be more difficult to attain.
GSE bundles loans and sells them as mortgage-backed securities
Following the money gets a little bit trickier once your mortgage payment gets into the hands of mortgage-backing giants like Fannie and Freddie.
At this point, GSEs take the payments on the loan and bundle them with many others. Think of it as a package. These packages are known as mortgage-backed securities (MBS). Pooling loans together allows large banks to then sell them as shares to investors.
The individual or institutional investors are ultimately the ones who make the funding available for mortgages because they purchase the loans.
Their ability to be repaid is contingent on the end-user - the homeowner - submitting their mortgage payment consistently.
Who are these investors?
Much like homes themselves, investors come in all shapes and sizes.
Generally speaking, though, investors that purchase shares in MBSes are large pension or mutual funds. Some of the more common ones include J.P. Morgan, PIMCO and Morgan Stanley. Their valuation is what allows them to buy and make the funds available to homeowners.
They make money by collecting on the dividends accrued through interest on these mortgage payments. In essence, the interest earned goes into these mutual funds as earnings on the original purchase of the mortgage security.
MBS were game-changers
Mortgage-backed securities revolutionized the residential real estate industry by making homeownership far more achievable for families operating on a budget who may not have adequate funds otherwise.
Created in 1963 through the Housing and Urban Development Act - during the administration of Lyndon B. Johnson - MBSes provided more liquidity in the marketplace by allowing non-bank financial institutions and investors to participate, as noted by The Balance.
Evidence of this fact is the homeownership rate, which naturally waxes and wanes but has risen significantly from 50-plus years ago. According to the most recent statistics available from the U.S. Census Bureau, nearly two-thirds of Americans own residential property. In the 1950s, homeownership hovered in the 40% range among single individuals, according to archived Census figures.
How paying off your mortgage benefits you long term
Being consistent with paying off your home loan is smart for a variety of reasons, not the least of which is it helps to improve or maintain your credit score. It also gets you on the road to saving more of your hard-earned money by fully owning your residence one check or automatic deduction at a time.
But if you have any kind of pension or retirement account with investments in bonds and mutual funds, you're building a better retirement - in a roundabout way - through the interest from those ongoing payments. According to polling conducted by Gallup, 62% of Americans who have yet to retire anticipate stock or mutual fund investments to be a source of income once they exit the workforce.
Following the mortgage payment pathway is a bit complicated. But starting your journey couldn't be simpler by going through Residential Mortgage Services. Contact us to learn more.