What is a mortgage?
A mortgage is a loan used to buy a home or real estate. You borrow money from a lender and agree to pay it back over a set period, usually 15 or 30 years. The property itself serves as collateral for the loan, which means the lender can take the property if you don't keep up with payments.
Principal and interest
Every mortgage payment has two main parts: principal and interest. Principal is the amount you originally borrowed. Interest is the cost the lender charges for letting you use that money. Over the life of the loan, you pay back the full principal plus all the interest that accrues.
Taxes and insurance (PITI)
PITI is an acronym that stands for Principal, Interest, Taxes, and Insurance. These are the four components that often make up a full mortgage payment. Here's what each part covers:
- Principal: the portion that pays down your loan balance.
- Interest: the cost of borrowing, based on your interest rate.
- Taxes: property taxes collected by your local government, often held in an escrow account.
- Insurance: homeowner's insurance, and if your down payment is less than 20%, private mortgage insurance (PMI) may also be included.
Amortization
Amortization is the process of paying off your loan through regular, fixed payments over time. Each payment is split between principal and interest. Early in the loan, a larger portion of your payment goes toward interest, and a smaller portion goes toward principal. As the loan matures, the opposite happens: more goes to principal and less to interest. An amortization schedule shows this breakdown for every payment over the life of the loan.
APR
The interest rate is the base rate used to calculate your monthly payment. The Annual Percentage Rate (APR) is a broader measure that includes the interest rate plus certain fees and costs, such as origination fees and points. Because APR includes these extra costs, it can be higher than the nominal interest rate. When comparing loan offers, APR gives you a more complete picture of the total cost of borrowing.
Frequently asked questions
What does PITI stand for?
PITI stands for Principal, Interest, Taxes, and Insurance. These are the four main components of a typical mortgage payment. Principal and interest go toward paying off the loan, while taxes and insurance are collected and paid by your lender on your behalf.
What is the difference between interest rate and APR?
The interest rate is the cost of borrowing the principal, expressed as a percentage. The Annual Percentage Rate (APR) includes the interest rate plus certain fees and costs, such as origination charges and points, so it reflects the true annualized cost of the loan. APR is typically higher than the interest rate when fees are included.