Mortgaging has paved the way for the easy and convenient acquisition of properties in recent times. Interestingly, you can own hectares of land and apartments with minimal income, thanks to mortgage payments. In order to purchase a house, you don't need to have hundreds of thousands of dollars at hand. Instead, you only need a downpayment.
While this is exciting, before signing a mortgage contract, you still have to understand the different methods of payments. Are you choosing the principal or escrow method? What are the pros and cons of these two methods? What is even a mortgage payment? Knowing the answers to these questions can affect you in more ways than one when it comes to your financials. Keep reading to learn more!
What Is A Mortgage Payment?
A common question faced by many is "what is a mortgage payment?" The definition is fairly simple. A mortgage payment, also known as a regular installment, is the sum of all fixed expenses paid to keep your home. These fixed expenses include principal and interest payments on your loan, homeowners insurance premiums and property taxes. Remember that although these are fixed expenses, they can vary at any time due to changes in interest rates or tax codes.
What Types Of Mortgages Exist?
There are several different types of mortgages available through lenders today: conventional loans and FHA loans, VA loans, and USDA rural housing loans. Mortgages come in two varieties: fixed rate and adjustable-rate (ARM).
How Does A Mortgage Work?
A home purchase is financed through a mortgage loan, which is simply a way to borrow money from a bank or another lending institution using your house as collateral. The total amount you ultimately borrow through your loan is known as the loan amount. This number combines your mortgage principal with any closing costs charged by your lender at the time of purchase. When you make monthly payments toward this debt, both the principal and interest portions contribute to paying it down over time. By knowing how much you owe today, how much you owe tomorrow and the interest rate you're being charged, you can determine how long it will take to pay off your loan or when the principal balance should drop.
Now that you have learned about mortgages, let’s dive into what the difference between escrow and principal is.
Paying Through The Principal
Paying the principal amount on your mortgage is a popular method of making payments in real estate. This essentially means you are making a payment to the actual mortgage amount.
Let’s backtrack. When you purchase a property, there is an agreement between the estate owner and the mortgager on the frequency and amount of money that will be paid bi-weekly or monthly. In this contract, other terms and conditions may also be specified. While you are making these payments, you are recognized as the legal owner of the property.
Before we go into the specifics on how a monthly mortgage payment is calculated, it's important that you understand that your mortgage payment actually consists of two distinct parts: principal and interest. These elements are usually expressed as a percentage so when one increases or decreases, so does the other.
Putting It Into Perspective: Principal
Assuming you signed a mortgage contract worth $200,000 using the principal model of payment. As part of your contract, you agreed to pay back the whole amount in a year using a 5% interest rate per annum.
The mortgage principal amount will be calculated each month after deducting the monthly mortgage payment with a constant interest rate.
Pros And Cons Of Paying Through The Principal
Let’s look at the pros and cons of paying through the principal.
The Pros Of The Principal Mode Of Payment Are
The Cons Of Paying Through The Principal
The cons of the principal model are:
Escrow Model Of Payment
The escrow mode of payment is very different from the principal model. Here, you are not only required to pay the mortgage principal and interest but also, taxes and insurance on your asset.
A written document or agreement is often signed by the two involved parties with the involvement of an intermediary also known as the escrow agent. The escrow agent acts as a body between both sides. The escrow agent also delivers the document of ownership to the borrower when all the terms have been met. The major difference between the principal and escrow mode of payment is that escrow involves property taxes, interest payments, and insurance payments while the principal model doesn't. Other dues may also be included in escrow mode of payment such as estate owners association fees and maintenance fees.
Many renters demand that renters create an escrow account to facilitate proper documentation and easy payment of taxes and other fees. In escrow, the estate owners have more rights over the property until the payment is completed. The advantage escrow accounts have over the principal model is that it allows the renters to have a budget for the future and also allows a longer period for payments. Because of this, mortgage properties become more affordable and easier to acquire.
Putting It Into Perspective: Escrow
A proper analysis of escrow models using a principal of $200,000 per 5℅ yearly rates.
As this is just an example, we suggest doing your research to figure out how much money you will be paying. Another thing to keep in mind is that appreciation and depreciation affects payment in the escrow model. If the property appreciates, the total payment increases as well. On the other hand, the total payment decreases when the property depreciates.
Pros And Cons Of The Escrow Model Of Payment
Let’s look at the pros and cons of paying through escrow.
Pros of Escrow Model Of Payment
The pros of the escrow mode of payment are:
Cons of Escrow Mode of Payment
The cons of the escrow model are:
What Is The Right Choice?
In conclusion, mortgage payments can be made through the principal or an escrow agent. Both modes of payment are reliable for mortgage properties. Similar to everything in real estate, both sides have their pros and cons.
The notable disparity between principal and escrow is that the principal mode of payment involves the payment of principal and loans only. The escrow mode of payment encompasses the principal, interest, taxes, insurance, and other fees. Renters need to evaluate their financial capacity and the time frame to repay the loan to select a suitable mode of mortgage payment. Lastly, to ensure adequate security, renters should run through any agreements or contracts with both their real estate agent and lawyer.