What
Is a Mortgage?
A
mortgage is basically a long-term loan that you arrange through
a bank or other financial institution, or even through the seller
of the property. The house and/or property serve as collateral 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.
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What
Is 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, known
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.
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