What is a Mortgage?
A **mortgage** is a specialized loan used to purchase or maintain a home, land, or other types of real estate. The borrower agrees to pay the lender over time, typically in a series of regular monthly installments. The property itself serves as collateral to secure the loan.
Understanding PITI (Monthly Cost Components)
When buying a home, your monthly financial obligation goes beyond just principal and interest. Lenders structure mortgage calculations around **PITI**:
- P - Principal: The actual portion of the monthly payment that goes toward reducing the balance of your loan.
- I - Interest: The fee charged by the lender for borrowing the principal. It is calculated monthly based on the current balance.
- T - Taxes: Property taxes assessed by your local county or municipality. Lenders typically collect this in an escrow account monthly and pay it on your behalf annually.
- I - Insurance: Homeowners insurance policies to protect the asset against damage from fire, hazards, or disasters.
How Private Mortgage Insurance (PMI) Works
**Private Mortgage Insurance (PMI)** is an extra monthly fee added to conventional loans when the down payment is **less than 20%** of the purchase price. PMI protects the lender if you default on the mortgage.
The rate for PMI ranges from 0.5% to 1.5% of the total loan amount annually, depending on your credit score and down payment percentage. Once the principal balance decreases to 80% of the home's original purchase value, you can request that the lender remove the PMI fee.
How to Avoid PMI
To minimize your monthly mortgage payments and keep cash in your pocket:
- Make a 20% Down Payment: This is the simplest way. Putting down 20% or more bypasses PMI completely.
- Lender-Paid Mortgage Insurance (LPMI): In exchange for a slightly higher interest rate, the lender pays the PMI. While this lowers the monthly itemized fee, the higher rate remains for the life of the loan.
- Piggyback Loans (80/10/10): Take out a primary mortgage for 80% of the value, a secondary loan (home equity line) for 10%, and put down 10% in cash. This keeps your main loan at 80% to avoid PMI.