Purchasing a home is not as simple as taking out a loan for the cost of the property. You also have to pay interest on the loan, insurance costs and property taxes. In some cases, you pay these costs separately. However, in many cases, you make one payment, some of which covers your principal loan payment and some of which goes into an escrow account that holds the funds to pay the additional costs.
Principal
The principal on your mortgage is the amount that you borrowed from your lender to complete the purchase of your home. In addition, you pay interest on the principal. Interest rates may be fixed or variable depending on the type of loan you have, and you continue to pay interest until your principal balance is paid off.
Escrow Account
An escrow account is one you pay into each month. The funds in this account are used to pay your homeowner's insurance and property taxes. This account usually is managed by your lender, which can make the payments for you. An escrow account is not required in all states or by all lenders; however, setting up an escrow account makes it convenient for you to have one monthly payment to cover home costs.
Mortgage Payment
When you make a mortgage payment, your lender applies the payment to the accrued interest and a portion toward the principal balance of your loan. The remaining amount goes into the escrow account and is saved until taxes or insurance payments are due.
Variable Payments
Even if you have a fixed interest rate, remember that property tax amounts and insurance premiums may change each year. Because your mortgage payment includes a deposit into your escrow account and not only principal and interest payments, your monthly mortgage payment may vary each year.
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