By Relocation.com Staff
The amount you pay monthly will include principal, interest, insurance and taxes (commonly known as PITI). At closing, tax and insurance escrows accounts are usually set up. When the tax and insurance bills come, the lender will pay these out of the escrow account.
Taxes:
Taxes are collected on property in a municipality and used to pay for schools, street cleaning and lighting, fire protection and various other needed community services. The idea is that all who pay the taxes in a municipality will in theory benefit from the payment of those taxes.
The municipality attempts to ensure that taxes are divided fairly and equitably based on the value of your property. This is called "ad valorem" (according to value). But in reality, the amount of property taxes you pay is dependent on the municipal budget requirements, not on the assessor's valuation of the property. The municipal budget is drawn up yearly and the money to pay for the various goods and services is paid from the property taxes collected.
Insurance:
Homeowners insurance provides financial protection in the event of an unforeseen disaster or accident. Insurance protects you from many different types of risks and there is a price or premium for this protection. There are standard insurance package policies. Deciding on what extra insurance options to accept is really an exercise in risk assessment. You will also need to ask yourself what level of coverage i.e. actual cash value or replacement value you wish to have and any deductible you can afford. The underwriters work for the insurance companies and decide your premium based on all of the above factors and on the actual risk to them.
Lenders want to make sure they are covered in the event a disaster occurs to the property. For home purchases, your lender will require that you have purchased and prepaid for insurance prior to or at closing. Your monthly payment to the lender will include 1/12 the amount of the yearly premium and is part of your monthly PITI. You will need to provide a proof of insurance such as a receipt at closing. This may be your minimum insurance on the amount of the purchase value minus land.
So why is the lender interested in paying the taxes and insurance?
In many states this is the law, but the history is more complex. Years ago, when lenders loaned money to people to buy homes and the homeowner defaulted on payments of taxes, the home was foreclosed and then sold to pay these fees. The taxes were the first to be paid out of the money from the sale. In other words, the taxes have the first lien on the property. Therefore, the lenders began requiring that escrows were set up at closing in order to protect themselves. The lenders pay these fees when they are due.