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How Mortgages Work

One benefit of buying a house is you can truly make it your own. Transforming your dream of homeownership into reality will likely require a mortgage, so it’s important to understand how they work.

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Unlocking the key to homeownership for most Americans means turning to a mortgage for the money needed to purchase a home. According to online sources, approximately $2.75 trillion in new mortgage debt was originated in 2022. Based on these numbers, mortgages are big business for lenders, but they are just as important to prospective homeowners. It’s critical to have a solid grasp on how they work before you go shopping for your dream home.

Mortgages, in particular mortgage payments, are comprised of four components: Principal, Interest, Taxes, and Insurance, or PITI.

Let’s explore each component of PITI individually.

  • Principal
    Principal is the amount of money you borrow from a lender to buy the property. The more you borrow, the higher your payment will be, since a portion of each mortgage payment goes to paying back what you borrowed.

  • Interest
    Interest is the cost of borrowing money from a lender. Your interest rate will depend on your credit score, the type of loan you choose, and a few other factors. The higher the interest rate, the larger your mortgage payment will be, since a portion of each mortgage payment goes to paying interest on the amount you borrowed.

  • Taxes
    Property taxes are assessed by your local government on the value of your property. The amount you pay can vary depending on several factors including the location of your home and the value of comparable homes in the area. The property’s assessed value and your tax rate may change often and can impact your mortgage payment.

  • Insurance
    Homeowner’s insurance protects you financially from the cost of property damage and other covered events. Mortgage insurance, on the other hand, protects the lender in case you default on your loan.