Taxes
Real estate taxes are assessed by governmental agencies and used to fund various public services such as school construction and police- and fire-department services. Taxes are calculated by the government on a per-year basis, but individuals can pay these taxes as part of their monthly payments. The amount that is due in taxes is divided by the total number of monthly mortgage payments in a given year. The lender collects the payments and holds them in escrow until the taxes are due to be paid.
Insurance
There are two types of insurance coverage which may be included in a mortgage payment. Like real-estate taxes, insurance payments are made with each mortgage payment and held in escrow until the bill is due. The first type of insurance is property insurance, which protects the home and its contents from fire, theft and other disasters.
The second type of insurance is PMI (mentioned above), which is mandatory for homeowners who purchase a home with a down payment of less than 20% of the home\'s cost. This type of insurance protects the lender in the event the borrower is unable to repay the loan. Because it minimizes the default risk on the loan, PMI also enables lenders to sell the loan to investors, who in turn can have some assurance that their debt investment will be paid back to them. PMI coverage can be dropped once the borrower has at least 20% equity in the home.
While principal, interest, taxes and insurance comprise a typical mortgage, some borrowers opt for mortgages that do not include taxes or insurance as part of the monthly payment. With this type of loan, borrowers have a lower monthly payment, but must pay the taxes and insurance on their own.
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