Kim Cook's Blog
Learning the nuances of buying a home does not take a college degree in mathematics. You do not even need to know calculus or trigonometry. The numbers all come from multiplication, division, and percentages. However, understanding the numbers is not all there is to know about mortgages. Debt finance has a language of its own, so here are some terms you may run across, what they mean, and how to use them.
What the terms mean
- Mortgage: A mortgage is a legal agreement between a lender (a bank or other creditor) and the mortgagee (the person receiving the funds from the loan) at a specific interest agreement for a specified length of time in exchange for taking the title or deed of the debtor’s property. Until the debt is paid in full, the condition of a mortgage typically is that the full ownership of the property remains with the mortgage lender. In simpler terms, this means that the bank or lender owns the home (or a percentage of it) until the debt is paid. The homeowners have use of the house for as long as they fulfill the terms of the mortgage agreement.
- Interest. The fee charged for the use of the money in the mortgage based on a percentage of the total amount. Interest percentages can be fixed (they do not change for the life of the loan) or variable—also call adjustable because they can vary based on outside, pre-determined circumstances.
- PITI. This acronym stands for principle, interest, taxes, and insurance. Together, these four items denote the amount of a mortgage payment when taxes and insurance are held in escrow.
- Escrow. When monies for taxes or insurance are collected monthly but not paid until they are due—usually quarterly for insurance and annually for taxes—they are held by a third party and protected until paid out.
- Amortization. The amount of interest you pay monthly on a mortgage is more significant at the beginning because it is based on the amount of principal owed. As the principal reduces, the amount of the payment that is interesting also reduces so more of the fee goes toward the principal. At the beginning of a loan with a fixed interest and fixed length, all the costs, and the principal-to-interest breakdown are available on an amortization chart.
When you buy a home with a mortgage, typically after paying a down payment (a portion you pay outside the mortgage) the rest is amortized using a standard calculation for every payment for the length of the loan. You do not need to learn the formula, though, because several mortgage calculators exist online to do it for you. Try this one with the amounts of your potential purchase, down payment, interest rate, and term (in years).