A mortgage
is basically a long-term loan that you arrange through a bank
or other financialinstitution, or even through the seller of
the property. The house and/or property serve ascollateral for
the loan.
A home
mortgage is most likely the largest debt you will assume. You
typically pay off that debt in monthly payments over a long
period of time, most often 15 to 30 years.
What's
in a payment? A monthly mortgage payment typically
includes the following,
known as PITI:
Principal
Interest
Real
estate taxes Property insurance and, often, private
mortgage insurance, know as PMI.
PMI
gives the lender protection if the homeowner should default on
the loan. The mortgage company charges insurance if the down
payment is less than 20 percent of the sale price or appraised
value. PMI usually can be eliminated once the principal balance
of the mortgage reaches 80 percent of the sale price or appraised
value, which is known as the loan to value (LTV) ratio.
The
process of paying the principal takes years because mortgages
are based on a repayment plan called amortization. During the
years of the mortgage, a homeowner pays a lot of money toward
interest in order to have manageable monthly payments on the
huge house debt. During the first few years, most of the
mortgage payments will be applied toward the interest. During
the final years
of the
loan, the payments will be applied primarily to the remaining
principal.
Example:
Let's
look at a $100,000 mortgage,
at a fixed interest rate of 7.5 percent,
for 30 years.
In three decades, the homeowner would pay $151,717 in interest.
Of
course, you cannot put a price on the pleasure of living in your
own home and building equity, an unencumbered interest in your
property. Equity grows as you pay off the principal of the mortgage
and as the property appreciates in value. Also, there are tax
incentives, since mortgage interest is a deduction on your federal
income tax.
Still,
the amount of interest you will pay may affect your decision
on what type of mortgage you choose.
