Chater 4: The Components of a Mortgage Loan

The four components of a mortgage loan are Principal, Interest, Taxes and Insurance – commonly referred to as PITI.

Principal
The principal is the amount of money you borrow. Mortgage loans are set up so that you pay more interest than principal in the beginning, and more principal than interest in the end.

Interest
The interest rate you receive will greatly affect your monthly payment and total cost of the loan. Fixed interest rates remain consistent over the course of the loan, and adjustable (ARM) interest rates change based on a variety of rates including prime, treasury bill, and LIBOR.

Taxes
Property taxes may be included with your mortgage payments, or paid quarterly. The amount of tax depends on where you live, and is usually assessed as a percentage of the property value. You may also have to pay local government taxes.

Insurance
A homeowner’s insurance policy protects you from financial losses on your property that might result because of fire, wind, or other hazards.

Potential Mortgage Related Expenses
If you buy a home that shares a common area, you will likely have to pay homeowner’s association dues. These fees cover the property’s management and upkeep of common areas.

You may have to pay private mortgage insurance (PMI) premiums if you borrow more than 80% of the home’s worth. This type of insurance policy pays mortgage lenders for part of their financial loss if a loan is not repaid. You may drop this coverage when you have achieved 20% equity.

Begin Saving

Because most people do not have immediate access to the large sums of cash required to buy a home, a savings plan will be necessary. After you have calculated the amount of money you need, decide when you would like to buy. Then divide the desired sum by the number of months you have to save.

Example: If your objective is to save $15,000 and you want to purchase a home in three years, then you’ll need to set aside about $416 every month ($15,000/36).

If the goal you have set for yourself is not feasible, consider expanding your time frame, saving for a less expensive home, or making changes to your income and expenses.

To make saving as easy as possible, have the determined sum automatically deducted from your paycheck or checking account and deposited into a separate savings account.

Pre-qualification Versus Pre-approval

Pre-qualification is a general projection on how much of a loan you might qualify for. The amount you are truly eligible for may be different based on your tax returns, credit report, and other factors.

Pre-approval is closer to the real application process. It is a firm commitment from a financial institution that for 60-90 days, barring changes in your financial situation, they will finance a specific amount.