Article 7: I Want To Buy A Home Now What
Dated: September 30 2020
Just like you, many first-time home buyers wonder how their monthly payment is applied to the different cost associated with owning a home. Today I am going to explain how the payment you make each month is divided up. Your payment will consist of principal, interest, taxes and insurance (often abbreviated as “PITI”), and sometimes additional fees, such as homeowner’s association dues and flood insurance. I will also explain some other terms which you may not be familiar with such as equity, assessed value, market value, and escrow accounts.
Equity is the amount you still owe towards your principle versus the value of your home. Your equity can increase two ways: by paying your mortgage each month and by your house appreciating in value. You can increase your home’s value by doing home improvements which make your home more desirable to buyers. The value of your home may also increase over time since historically housing prices always increase. We saw a sharp decline in home prices around 2008 due to the housing bubble bursting but over the last 10 years, we have seen home prices exceeding 2008 levels. In the short-term prices may go up or down but over time they have historically always gone up.
Principal is the money you borrowed to purchase the home. At the beginning of your loan term, a lower amount of your payment goes towards the purchase price and a higher amount goes towards the interest cost for your loan. As you pay this amount down this is the equity you have in your home.
Interest is the cost of borrowing money. This is how the bank makes money for loaning you the funds to buy your home. Over the life of your loan, this will be the second largest expense for your purchase. You can reduce the amount you pay in interest by finding a more favorable rate before you buy a home, as well as by making extra payments towards the principle of your loan.
The assessed value of your home is how your local government figures out the amount of taxes you owe each year for real estate and school taxes. The assessed value is multiplied by a millage rate and each areas millage rate is different. This figure is not the actual value of your home but rather just a base number that the local government uses to apply taxes. The assessed value is not changed often but the millage rate is adjusted based on the financial needs of the local government.
Local tax authorities determine tax rates in Pennsylvania based on their revenue needs. Rates are expressed as “mills.” One mill is equal to $1 of property tax for every $1,000 in assessed value.
Real estate taxes:
Real estate taxes are paid by homeowners to local governments and are usually a percentage of the assessed property value. These taxes are usually paid at the beginning of the year, but it is not uncommon to have these payments escrowed and paid each year to the mortgage holder and then they pay the tax bill each year for you using the funds you paid each month.
School taxes are how we fund our school district in Pennsylvania. The amount of taxes varies by school district and are also a percentage of the assessed property value. These taxes are usually due in the middle of summer but like the real estate taxes, it may be escrowed by your lender.
Home owner’s insurance:
Insurance helps protect against financial loss from fire, natural disasters or other hazards. Most lenders require you to have a homeowner’s insurance policy on your home because it will help protect their investment as well as yours.
Private mortgage insurance:
Most lenders require PMI when a home buyer makes a down payment of less than 20% of the home's purchase price – or, in mortgage-speak, the mortgage's loan-to-value (LTV) ratio is in excess of 80% (the higher the LTV ratio, the higher the risk profile of the mortgage). And unlike most types of insurance, the policy protects the lender's investment in the home, not yours. On the other hand, PMI makes it possible for people to become homeowners sooner.
If your home is located in an area that FEMA has designated to be at a higher risk of being damaged by flooding your lender will require you to pay for flood insurance. The damage from a flood is not covered under a standard homeowner's policy. Flood insurance is a special policy that is federally backed by the National Flood Insurance Program (NFIP) and available for homeowners, renters and businesses.
If your lender set up an escrow account for your mortgage, each month in addition to your principle and interest payments, you'll also make an escrow payment to cover your property taxes and homeowners insurance. Your lender will deposit this amount into your escrow account and will pay for these items on your behalf when they are due.
Home owner association fees(HOA):
Some homes are part of Home Owners Association that charge fees either monthly or yearly, they may also require a onetime upfront fee to be paid at closing. These fees pay for common area maintenance which can include flower beds, sidewalks, gym, pool, gates, parks, and other amenities that are part of the development or community.
If there are other terms you are not familiar with that I did not cover in this list, feel free to contact me and ask me what it means. I am here to help in any way I can, I look forward to chatting with you.
If you have more questions about buying a home for the first time, please feel free to call or email me directly at:
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