How does a mortgage work, and what makes up a monthly payment?

A mortgage is a loan specifically used to purchase real estate. You borrow money from a lender (like a bank) to pay for the home, and the property itself serves as collateral. If you are unable to repay the loan according to the agreement, the lender has the right to take possession of the property through a process called foreclosure.

You pay the loan back over a set period (the "term"), usually 15 or 30 years, through monthly installments. These payments include the repayment of the borrowed amount (the principal) plus the interest charged by the lender for the loan.

Your monthly mortgage payment is typically made up of four main components, often referred to by the acronym PITI:

1. Principal: This is the portion of your payment that goes directly toward paying down the original amount you borrowed. In the early years of a mortgage, a larger portion of your payment goes toward interest, but over time, more goes toward the principal.
2. Interest: This is the cost of borrowing the money. It is calculated based on your interest rate and the remaining balance of your loan.
3. Taxes: Most lenders require you to pay a portion of your annual property taxes each month. This money is held by the lender in an escrow account, and they pay the tax bill on your behalf when it is due.
4. Insurance: This includes your homeowners insurance (which protects the property against damage) and, if applicable, private mortgage insurance (PMI). Like taxes, these are usually collected monthly and held in escrow to be paid when the premiums are due.

Depending on your specific loan terms, you might also have additional monthly costs, such as homeowners association (HOA) fees, though these are typically paid directly to the association rather than through your mortgage lender.