Your monthly mortgage payment typically is made up of four components: principal, interest, taxes, and insurance, together known as PITI. The principal refers to the part of the monthly payment that reduces the remaining balance of the mortgage. The interest is the fee charged for borrowing money. You can determine the amount of principal and interest by using our Mortgage Payment Calculator.
Taxes refer to property taxes your community levies which are generally based on a percentage of the value of your home. The lender usually collects 1/12th of the yearly property tax bill each month. The lender collects taxes in advance and places the money in an escrow fund.
Lenders won't let you close on your home loan if you don't have hazard insurance to cover your home and your personal property against losses from fire, theft, bad weather and other causes. The insurance amount is collected and paid much like the taxes. Each month 1/12th of the insurance bill is collected and stored in an escrow account until the bill is due. Even if you pay cash for your home, it is a good idea to buy hazard insurance in the event your home is damaged or destroyed.
Principal and interest comprise the bulk of your monthly payments in a process called amortization, which reduces your debt over a fixed period of time. With amortization, your initial monthly payments are largely interest, and as the loan matures, a greater portion of your payment is allocated toward the principal.
Mortgage escrow accounts are special accounts set up in which money is held to pay property taxes, fire and hazard insurance premiums, mortgage insurance premiums, and other escrow items.
Escrow accounts ensure that these items are paid in a timely fashion. They guarantee that there is always enough money to pay these bills when they are due so that the homeowner avoids the risk of lapsed insurance coverage or delinquent taxes. With escrow accounts, homeowners do not have to worry about coming up with several large, lump sum payments, each with different due dates, throughout the year.
Mortgages have lower rates and down payments because of escrows accounts. Escrows accounts protect the interest of investors of home mortgage loans by making them more attractive and secure as investments. Escrow accounts also benefit local governments by providing a more efficient, less expensive means of tax collection.