Before you borrow money to buy a home, it’s important to understand the key terms so you fully understand the mortgage payment. Unlike other loans, your payment may consist of more than just principal and interest.
Here are the terms you must know before taking out a mortgage.
The principal is the amount you borrow. For example, if you are buying a home for $200,000 and you’re putting down $15,000, you would borrow $185,000 – this is your principal balance. Your mortgage payment will include a prorated amount of principal each month. At the start of the loan, you’ll pay less principal and more interest, but as you move through the term, you’ll pay more principal and less interest.
Speaking of interest, this is the fee the lender charges to loan you the money. It’s how they can continue to make loans. You can apply for a fixed interest loan or an adjustable-rate loan. A fixed interest loan has the same interest rate for the life of the loan (it never changes). An adjustable-rate loan has a ‘teaser rate’ or introductory rate. The rate adjusts annually after the adjustment period which is usually 3 – 10 years.
Your interest charges decrease as you pay the principal balance down which is how your payment becomes more principal-based than interest-based as you get further into the term.
Real Estate Taxes
If you escrow your real estate taxes and insurance, you’ll pay 1/12th of your taxes each month, plus a small cushion. The taxes are added to your mortgage payment but the amount for your taxes is set aside in an account. The lender then pays your taxes from the account when they come due. This makes it easier to ensure you pay your taxes on time as it’s a condition of your loan.
Another part of the mortgage payment is your homeowner’s insurance. If you include it in your escrow, you’ll pay 1/12th of the annual premium each month with your mortgage payment. Like the real estate taxes, your lender will pay your premiums on your behalf from the escrow account.
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