Understanding your mortgage payment
When purchasing a home, you might be wondering about your monthly mortgage payments. How much can you expect to pay, and what goes into calculating those payments? The monthly mortgage payment includes more than the loan principal; it also includes items such as taxes, insurance, interest and more. A few variables used in that calculation include:
- Principal. The principal is the total amount that you finance. For example, let’s say that the purchase price of a home is $350,000, and you put down 5% on the home. As a result, you finance $332,500, which is the loan’s principal.
- Interest. The interest is the cost of financing the loan. At the start of the loan, most of your payment will be interest, but over time a larger portion of your payment amount will go toward the principal.
- Escrow payments. A home purchase includes additional financial obligations, including property taxes and insurance. These vary based on your house’s details and geographic location, but expect to pay at least a few hundred extra dollars each month.
- Private mortgage insurance. If you put down less than 20% of the purchase price of the home, you may be required to pay private mortgage insurance (PMI). This is insurance designed to protect your lender if you default on the mortgage. The cost of PMI is generally between 0.55% and 2.25% of your original loan amount and is paid on a monthly basis. Once you have at least 20% equity in the home, you may request that your lender drop PMI.
Understanding HOA fees
If you purchase a condo or a home in a planned community, you may be responsible for homeowner’s association (HOA) fees. These fees cover a variety of shared expenses such as upkeep on common areas, the pool, tennis courts and other recreation areas. Landscaping may also be included. This fee is outside of your mortgage payment (which includes taxes, interest, insurance and PMI) and is paid on a monthly basis.
Deciding how much house you can afford
A lender uses a basic calculation to determine how much house you can afford. The formula relies on two inputs: your total household gross income and your total monthly debt. Most financial institutions prefer a debt-to-income (DTI) ratio that doesn’t exceed 36%; however, some will go as high as 40% to 50%. A higher ratio may require a larger down payment or a higher interest rate. A mortgage calculator can help you quickly determine your ratio, or you can calculate it yourself using the following information:
- Monthly gross income. Gross income is the total amount of money that you earn monthly before taxes. Add up total monthly gross income for all borrowers on a loan.
- Monthly debt. Debt includes a variety of items, such as car payments, student loan payments, credit card payments, and your estimated mortgage amount.
Calculate your DTI ratio by dividing your total debt by your total gross income. For example, let’s say that you and the co-borrower each earn $3,000 gross income per month for a total of $6,000. Total debt, which includes your potential mortgage, is $2,500. Divide $2,500 by $6,000 to get a DTI ratio of 41%.
If your DTI ratio is too high, consider paying off debt. Make a list of your debts, and determine which are highest each month. For example, if you have credit card payments, could you pay off lower balances and decrease total monthly debt obligations? Can you refinance an auto loan into a lower total monthly payment? Find opportunities to lower your debt payments.
Alternatively, you could consider making a larger down payment. Doing so will decrease your monthly mortgage payment and help lower your overall DTI ratio.
How does a mortgage calculator help?
Determining how much you can afford is a good first step toward homeownership. A calculator can help you review different scenarios to determine how much you can afford and which is right for your circumstances. The rates in a mortgage calculator can be easily adjusted to reflect your current situation.
- Home loan term. Adjust home loan terms to determine how the length of your loan affects your monthly mortgage payment and the interest you pay over the life of a loan. For example, a 15-year mortgage loan will increase your monthly payment but drastically decrease the amount of interest you pay over the life of the loan.
- Evaluate adjustable rate mortgage (ARM) options. An ARM starts with a low interest rate and then adjusts over a specific period of time. For example, if you’re planning to be in a home for five years or less, you may consider a 5/1 ARM that offers a low interest rate for the first five years and consequently, a lower monthly payment.
- Adjust down payment options. If you find that your monthly payment is too high, consider experimenting with different down payment scenarios. For example, if you put down 5% instead of 3%, what’s the impact? Keep in mind that if you’re a first-time homebuyer, you may have access to down payment assistance programs through your state’s resources.
- Determine whether your price range is too high. A loan calculator can help you understand what you can reasonably afford based on all of the costs associated with owning a home, including taxes and insurance, PMI, and any relevant HOA fees. You can adjust your budget accordingly as you start to experiment with different pricing scenarios.
Using a mortgage calculator to your best advantage
A mortgage calculator can help you get a clear idea about the terms that you want on your mortgage rate. For example, a low interest rate may be critical, or the ability to make a small down payment with a higher interest rate may be acceptable. When you can successfully calculate different scenarios, you can better understand the next best steps.