A mortgage is a type of loan where you borrow money to buy a home. You usually put down a large amount of cash, and then pay off the rest of the purchase price over time. The lender then holds a deed to your home until you pay off the debt.
The terms of a mortgage can be very complex and involve many different components, so it is important to understand them well. This will help you to make better-informed decisions and to avoid common pitfalls.
Typical Mortgage Components
The mortgage is typically made up of four components: principal, interest, taxes and insurance. The principal portion is the money you pay toward the outstanding balance of your mortgage, and the other three components are payments for the taxes and insurance that are tacked onto the monthly payment.
Your mortgage payment will be determined by the type of loan you have, the property youre buying, your down payment, and your interest rate. Its also a good idea to consider other expenses such as utilities, HOA fees, and home maintenance costs.
Credit: Your credit score is one of the most important factors in determining how much you can afford to borrow for a house, and a lower credit score could mean a higher interest rate. To improve your credit score, be sure to keep your debt-to-income ratio low and dont overspend on new debt.
Interest: The interest rate on your mortgage is based on the risk that the lender takes by lending you the money, and it can vary significantly based on current market rates. Its a good idea to shop around for the best mortgage rates before you decide to take out a loan, since a lower mortgage rate can save you thousands of dollars over the life of your mortgage.
Taxes: The amount of property taxes you owe on your property will depend on the propertys location and the type of mortgage you have. The lenders collect these taxes in your mortgage payments and keep them in an escrow account until theyre due.
Insurance: Similarly, your homeowners insurance bill will be tacked onto your mortgage payment and held in an escrow account until its due. Your lender will send these bills to your insurance company on your behalf, which can be a good way to reduce the cost of these bills.
Term: The length of your loan, generally measured in years. The shorter the term, the lower your payments will be.
In the United States, most mortgages are for 30, 20, and 15 years. A longer loan, such as a 25-year mortgage, will require larger payments than a shorter term, but it may be more affordable overall.
Mortgages come with several advantages, including the ability to deduct the interest from your taxes. However, you must itemize your deductions to receive this benefit.