Buying a home is one of the biggest purchasing decisions one will make in their lifetime. The high price tag that accompanies a home for sale makes figuring out how you’re going to pay for the home can become a cause of confusion and stress. With so many things to consider when figuring out what house you can reasonably afford, it is important to ask yourself some questions: How much will my monthly mortgage payment be? How do they calculate my mortgage rates? and What else do I need to pay for?
The first step with any large transaction is figuring out how you will pay for it, and your home is no different. There are many factors that you should consider and that your lender will ultimately take into consideration as well.
One of the first things that lenders do is take a look at your overall credit score by requesting a credit report. If you’re diligent and responsible with your credit cards and make sure to pay them on time, your credit report is usually not an overall cause of concern.
If, however, you have an array of late payments under your belt, little credit due to not having credit card accounts, or have filed for bankruptcy at one point, receiving a loan for a home will be a much more complicated ordeal.
PITI: Establishing a Mortgage Payment
Before you determine how much of a mortgage payment you can afford, it is wise to understand what a mortgage payment consists of.
There are four things that typically make up mortgage payments: principal, interest, taxes, and insurance.
The principal of a loan is simply the amount that you borrow against the house. For example, if you buy a $250,000 house and put 20% down ($50,000), the principal amount that you’ll owe is $200,000.
Your lender will calculate interest (known as an interest rate) based on the principal and is seen as a lender’s “reward” for loaning a home buyer money.
Real estate taxes are relatively self-explanatory but things like property taxes vary based on your location. Taxes fund various public services like schools and emergency response organizations like police and fire departments.
Insurance can be divided into two subsets: property insurance and PMI (private mortgage insurance). Private mortgage insurance, which is required when your down payment is less than 20%, is insurance that protects a lender in the off chance that you’re unable to repay the loan in full. This subset of insurance can be dropped once you have 20% equity in your home if you have a conventional loan.
While taxes and insurance are usually included in mortgage rates, borrowers can opt out of having them included in their overall loan amount. While this will lower a monthly payment, borrowers are then responsible for making the extra payments for taxes and insurance on their own.
Remember that the cost of home ownership is higher than your monthly mortgage payment. When deciding on a home and determining what you can afford, various products and services need to be added into your overall budget.
For instance, ask if the community where you’re considering purchasing a home requires a monthly HOA fee. Additionally, it is crucial that you consider all of your other living expenses. Car payments, utility bills, cell phone and internet payments, healthcare costs, groceries, auto upkeep, entertainment, and other various costs of living ultimately reduce how much you’re able to spend. While you may make a certain amount of money a year, don’t base your mortgage estimates on that set amount without taking into consideration how much of your annual earnings you need to spend on your other various living expenses.
Types of Mortgages
There are several different types of mortgages. The three most common mortgage types are those that have fixed rates (a “fixed rate mortgage”), adjustable rates (adjustable rate mortgages), and semi-fixed rates (a balloon loan).
Out of the three, a balloon loan is the least common. A balloon loan carries a shorter loan term than the others. Usually lasting five years, a balloon loan divides the payments as if the loan were a regular 30-year loan. Then, after five years, the borrower pays the remaining balance.
For example, let’s say you got a $100,000 loan. Your interest rate is 4% and is based on a fixed 30-year mortgage. Your monthly payments are $477. After five years, the balloon loan requires that you pay the full balance of $90,448.
Adjustable-rate loans adjust with your interest rate. When you’re first making payments, your lender will calculate those payments based on your current interest rate. When (or if) that rate adjusts, as will your payments and your overall loan term.
A fixed-rate mortgage is the most common of the three. Usually, over the course of 30 years, a fixed-rate mortgage establishes a monthly payment based on your loan amount, interest rate, and your loan term. Your mortgage lender crunches the numbers and lays them out so you can see what your payments are over the loan term.
States differ when it comes to mortgages and the various offers that lenders can make. Take a look at your state laws are and what the state law is regarding lending to see what your mortgage includes.
Using a Mortgage Calculator
A simple Google search gives you over 200,000,000 results for mortgage calculators. Mortgage calculators like this one are great tools to use when you’re trying to determine how much you can afford when shopping for a home. However, it is important that a borrower understands how to calculate mortgages.
Your mortgage is a large amount of money made up of multiple things. Because of that, they’re a bit difficult to calculate. Mortgages change from borrower to borrower and lenders calculate them using an array of variables. While mortgage calculators are great for an overall estimation, don’t assume that a lender will propose the same amount.
Getting a second opinion on the mortgage you’re using is crucial to the home buying process. But as important as it is to get a second opinion, it’s imperative that you keep timing in mind.
To avoid affecting your credit score, you need to get a second opinion within 14-30 days (depending on your location) from the completion of your initial mortgage pre-qualification. That’s because a second opinion requires another lender to run a credit inquiry.
If the inquiry falls within the 14-30 day timeframe, the credit bureau considers all inquiries as one inquiry. That means it won’t affect your credit score. Before seeking out an initial inquiry, look into what the timeline is based on where you live, for credit inquiries.