The anatomy of mortgage payments - Basic structure and components
Most individuals don’t have the capacity to purchase a home outright from their savings and thus need to pay for it through monthly installments. In simplest terms, mortgage is a long-term loan primarily designed to help the borrower purchase a house. Normally, the borrower will have to make an initial down payment of 20% of the value of the home and repay the principal on a monthly basis, as well as the interest payments to the mortgage lender. In addition, there are also property taxes and home insurance payments. The home, as well as the land, serves as collateral in the event that the payments are not made. This means that the lender has the right to seize the property if the borrower is not able to make the mortgage payments. There are many different types of policies as well as terms and conditions that govern mortgage loans and mortgage payments. Below are the basic components and structure of a mortgage.
The history of mortgage
Almost everyone who buys a home has a mortgage—even the rich. Monitoring mortgage rates has become a standard part of the financial culture. While it is ubiquitous, mortgage as we know today hasn’t always been around. It only sprouted in 1934 when the government created a mortgage program to help people overcome the Great Depression. The modern mortgage minimized the required down payment to buy a home and therefore increase the amount that the homebuyers can borrow. Before this program took place, the minimum down payment required to purchase a home was a whopping 50%. For most people, that amount takes a lifetime to save up. Today, the minimum down payment is normally 20%. There are even mortgage policies and programs that offer down payment that is significantly lower than the standard 20%, usually bundled with some form of payment protection insurance such as Private Mortgage Insurance or PMI.
The basics of mortgage payments
Commonly, mortgage payments are made every month. The factors that determine how much the individual has to pay every month will depend on the size and terms of the loan. The size is the amount of money borrowed from the lender and the terms refer to the length of the time in which the loan has to be paid pack in full. The relationship of the size and terms of the loan is usually inversely proportional: The longer the term, the smaller the monthly payments.
Components of a mortgage payment
The amount of mortgage payment does not end with the size of the loan and the terms of the payment. The calculation of the mortgage payment composes of four factors: principal, interest, taxes, and insurance, or what is called the PITI. The principal and interest go directly to the lender while the taxes and interest are held in escrow. Rates can depend on a number of factors as well as mortgage payment protection quotes, when applicable.
Principal
The principal is the amount of money borrowed from the lender and needs to be repaid in full over a period of time. For example, if the individual borrows $100,000 worth of mortgage to purchase a $100,000 home, the principal is equal to $100,000. The amount of repayment of the principal depends on the structure of the loan. Most loans are structured so that the principal returned to the lender starts small and increases for every mortgage payment. The first years of mortgage payments consist mostly of the interest payments and the final years of the payments mostly go to the principal repayment.
Interest
The interest is the profit that the lender will make in loaning mortgage to the borrower. In a way, it is the reward for taking the risk of loaning money to the borrower. For ensuring repayment, some lenders may require mortgage payments insurance. High interest rates translate to high mortgage payments. Thus, when taking a loan, the borrower has to take the interest rates into regard so as to determine if they have the capacity to repay a mortgage. Higher interest rates reduce the amount of money that a borrower can take and lower interest rates increase the amount of money they can borrow. A 6% interest rate on a $100,000 mortgage with a 30-year term will be equal to $500 monthly interest plus $99.55 principal when computing for monthly mortgage. A 9% interest on the same amount and terms will equal to around $804.62 monthly payment.
Taxes
Real estate taxes are required by law and assessed by authorized government agencies. These taxes go to funding various public services such as the police and fire department and the construction of public schools, roads, and bridges. Property taxes are collected on a per-year basis but the borrower can opt to pay this in monthly installments as part of the mortgage payments. The annual property tax is simply divided into 12 months or the total number of mortgage payments in a year. The lender collects the payment and holds the money in an escrow account.
Insurance
Insurance, like taxes, are paid monthly as part of mortgage payments and are held in an escrow account until they are due to be paid to the insurance company. There are primarily two kinds of mortgage that could be included in the mortgage payments. The first type is property or buildings and contents insurance, which protects the home and its contents from disasters such as fires and theft. The second type of insurance is Private Mortgage Insurance or PMI. This is usually mandatory for those who buy a home with less than 20% down payment. This type of insurance protects the lender from losses in the event a borrower defaults on his or her payments and a foreclosure ensues. PMI minimizes the default risk on a loan because it assures the lender that their debt investment will be paid back. PMI can be dropped when the borrower’s equity reaches 20%.
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