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Mortgage Basics

Let's first start with a definition on what a mortgage is. It is the borrowing of money for the purchase of a home, where the latter serves as a guarantee that you will return the money. This means that the failure to do so gives the lender the right to take your home.

In case you have some cash free and want to reduce the amount of money you have to borrow, you can make a down payment. It is paid up front. There is no limit on the amount of down payment you can make. However, the higher the amount of the down payment, the less money you will have to return and the less the payment you have to make every month.

There are several components, called PITI, which make up the monthly payment.

The first one is the principal. This represents the initial sum that you borrow from the lender after you have made a down payment. Additionally, this is the money which you are funding.

The second component is the interest. It is what the lenders charge you for lending you their money. It is calculated as a percentage of the principal.

A third component is property taxes which may be placed in an escrow account and withdrawn from there when the time to pay comes.

Insurance of the property may be also required. The type of insurance depends on the risks your property is exposed to. For example, if it is in a flood risk zone, you may have to make a flood insurance. Private mortgage insurance is required when you don't have 20% equity in your home. PMI may come at a high cost, so it may be reasonable to make a higher down payment to negate the potentially negative effect of this insurance.

The term amortization is used to refer to the incremental payment down of the mortgage through installments. Most of the mortgages have the structure of small portion of the monthly payment going to the principal and a larger one to the interest during a specific time period. The monthly payments are calculated in such a way that the borrowed money is returned for a pre-determined time period.  

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