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Buying a home can be one of the most rewarding investments you will ever make. However, it can also be one of the most costly. As a result, many lenders suggest prospective buyers determine a home's monthly mortgage payment before making a commitment. This will help borrowers better gauge if a property will comfortably fit within their current budget.
But, what exactly goes into a monthly loan bill? Let's take a look:
PITI: The Four Elements of Mortgage Payments
Mortgage payments are typically made up of four key parts — principal, interest, tax, and insurance costs.
The principal portion of a monthly payment goes towards paying down a loan's balance. With each principal payment, you increase home equity and become closer to owning your home free and clear.
The interest portion of a monthly payment is the amount a lender charges for loaning out monies. Initially, the largest part of your mortgage payment will be dedicated towards paying off the interest. However, as time passes, more of the monthly payment will go towards paying down the principal.
Real estate taxes are often escrowed and then included in mortgage payments, as well. Taxes serve to pay for municipal services, such as public schools and road maintenance. Keep in mind, tax rates can vary significantly from area to area and can be quite costly. Therefore, it's important you find and determine your exact local tax rate prior to closing on a home.
Homeowners insurance will also be included in your monthly mortgage payment. Remember, homeowners insurance provides you, the buyer, with protection in the event of an unforeseen natural disaster or unplanned event.
In addition, if you are unable to put down 20 percent at closing, you may also be responsible for paying private mortgage insurance or PMI. This type of insurance protects the lender in case you are unable to repay the loan amount and default on the mortgage.
Keep in mind, however — the cost of PMI can vary based on several factors, including but not limited to: loan amount, loan-to-value ratio, property type, and credit score. As a result, it is important that you discuss a lender's practices and fees regarding PMI.
Determining your future monthly mortgage payment before settling on a home can be a wise decision. By calculating the principal, interest, taxes, and insurance costs, you may be able to better determine just how much owning that dream home will actually cost. So before you sign any settlement papers, make sure to do some upfront research and speak with your lender, real estate agent, and local tax authorities about current homeownership expenses — after all, it never hurts to be prepared!