First Home Buying

PITI is the acronym that describes the contents of your monthly mortgage payment: Principal, Interest, Taxes and Insurance. So when you see those internet banner ads offering an unbelievably low mortgage payment, realize that - along with the possibility that they’re completely bogus - they might not be telling you the whole story.

Principal

This is not the administrator with whom you had frequent run-ins in middle school. Alas, this kind of principal is not your pal at all, but rather it’s the amount you told the seller you’d pay them for their house. Over the course of many years.

Interest

Interest is the amount of money the bank charges you for borrowing their money. When you start out on a conventional 30 year mortgage loan, almost your entire payment will be interest. The ratio between interest and principal changes on a sliding scale so that by the time the final payment of the 30th year rolls around, you’re paying mostly principal. In other words, the lender gets most of their profit up front because you pay large chunks of the interest balance within the first few years, and gradually less as time goes on.

If you consider how few mortgages actually last 30 years without a piece of property being refinanced or sold, you understand why lending can be such a rewarding business. If you know anything about foreclosures, you can then consider how lenders who were expecting to be rewarded so well ended up doing so poorly when they got stuck with tons of foreclosed property. They tried to take advantage of people interested in a good first home buying experience and ended up paying for it. For you, the homeowner, interest is the price you pay for living the American Dream. It really only has one positive quality: it’s tax-deductible, so every cent of interest you pay on your mortgage reduces your taxable income. More on how interest works here.

Taxes

Usually, if you have a good municipal system and a worthwhile lender, your property taxes are rolled into an equity account and paid for you once or twice a year depending on local procedure. The lender calculates the amount you should be charged in property taxes per year, based on the assessed value of the property and the tax rate of the city or county where the property is located. This amount is divided by the number of mortgage payments you’re scheduled to make in a year (usually twelve, but not always), and is added on top of your principal and interest. Since the year-over-year value of a home is likely to change at least somewhat, and municipalities often alter their tax rates as well, your monthly payment may shift up or down slightly over the course of your mortgage.

Insurance

There’s another page on this site that explains how mortgage insurance works in detail, but to put it basically, mortgage insurance is meant to protect your lender from you defaulting on your loan and causing them lots of headache. It doesn’t necessarily always accomplish that goal, but you pay it as long as you owe the lender more than a certain percentage of the value of your home, and you stop paying it once you’ve paid off at least that amount (usually 20%). Like mortgage interest, mortgage insurance is tax-deductible.