What is the Real Cost of a Mortgage?

by Andrea Davis

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The total cost of a mortgage is comprised of four main elements:

1. Principal
2. Interest
3. Taxes
4. Insurance

PITI is part of the formula that mortgage lenders use when calculating your affordability ratios. Many times home buyers ignore these additional costs when figuring how much of a home they can afford.

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Principal represents the amount you borrow, which has to be repaid over time.

Interest is the cost that mortgage lenders charge for the use of their money during your repayment schedule.

Taxes are an assessment that local governments collect on property to pay for local services. Property tax rates will vary by location and can affect your total cost and affordability.

Homeowner's Insurance will be required to replace the value of loan in the event of a disaster such as fire, earthquake, flood, etc.

Understanding Escrow
Property taxes and insurance costs must be collected and paid when they are due.

In most cases, mortgage lenders will make the collection by allocating the amount you need to pay for taxes and insurance each month to your mortgage payment.

These collections are placed in escrow, a depository account that the bank manages.

Your total monthly mortgage payment will include payments for real estate taxes, insurance, and Private Mortgage Insurance (PMI) and other items that are placed in escrow and used to pay taxes, insurance, PMI and other items on your behalf when they come due in the future.

Note that the escrow portion of your monthly payment may increase or decrease, depending on the change of your taxes and insurance assessments.

If your mortgage does not have an escrow account, you will be required to pay your taxes and insurance separately and show proof of payment to your lender.

Local Property Taxes
Your county and city may levy taxes on your real estate property. These taxes pay for government services such as schools, roads, police, and other community services. The annual tax is usually calculated as a percentage (factor) of your property's appraised market value. For example, an assessment may look like this:

$0.94 per $100 in appraised value

This calculates into a tax factor of 0.94% on the appraised value of your home Contact your local community and county officials to determine your county and city tax factor. And, keep in mind that many of these local real estate taxes may qualify for tax deductions. Check with your tax advisor for more information. At your home closing, you will be required to pre-pay up to one year's cost of your property tax. Then each month, your loan payment will include 1/12 of the annual property tax that will be deposited in your escrow account until the property tax payment is due.

Hazardous Insurance
You may be required to carry hazardous insurance on your home in the event of a fire, flood, disaster , and any other natural disaster that destroys or partially destroys your home.

The insurance will protect your investment (and the lender's) and repair any damage that may occur. The annual premium may vary depending on your home area and location. You must provide proof of insurance before closing and settlement.

At your closing, you may be required to prepay up to one year's cost of hazardous insurance.

Then each month your loan payment will include 1/12 of the annual hazard insurance premium to be deposited in your escrow account until payment is due.

Other Costs (PMI)
There may be other associated costs that may be included in your escrow payment such as Private Mortgage Insurance, tax liens, etc. Check with your real estate agent or your legal council to determine what other charges may apply.

Private Mortgage Insurance (PMI) Private Mortgage Insurance (PMI) is mortgage default insurance that is required for all conventional mortgage loans with less than a 20 percent down payment. It is designed to pay the lender a portion of the outstanding balance of a loan in the event the homeowner defaults.

If PMI is required as part of your loan, the initial annual premium will be included in your closing costs while your subsequent premiums (1/12th of your annual premium) will be included in your monthly mortgage payments and deposited into your escrow account.

You need to check with your lender to estimate your cost percentage for PMI if your down payment is less than 20 percent. Nationally, the average annual percentage is around 0.005 of your loan balance.