Can you afford to buy a home? When you are in the decision-making process about whether it makes more sense to rent or buy, one of the most important pieces of the puzzle is to know how the monthly mortgage payment will compare to what you are currently paying in rent.
The U.S. Census Bureau reports that the average mortgage payment in America is $997. However, included in that figure are the fortunate Americans who have already paid off their mortgage. If you take that group out of the picture, it turns out that the average mortgage payment for most folks across the country is somewhere between $1037 and $1211.
Realistically, however, the amount that you will pay for owning a home can vary from those figures quite a bit. This guide will help you understand all you need to know about calculating your monthly mortgage payments.
What are the typical monthly costs of owning a home?
The most significant expense you will have when you own a home is the mortgage payment itself. Your mortgage payment consists of:
Your principal balance is the actual amount you borrowed from your lender. For each payment you make, your principal balance decreases and your home equity increases.
Interest is the amount of money you will pay the lender for the money you borrowed. You pay a portion of your interest as part of your mortgage payment each month.
Private mortgage insurance (PMI)
Many lenders require that you pay PMI until you have built up at least 20 percent equity in your home.
Just like car insurance covers damages to your car, homeowner’s insurance protects you in the event your home becomes damaged in some way. Policies vary, so it is important to research which policy works for you. Lenders typically require you to carry homeowner’s insurance to protect their investment in your home until you have paid your mortgage loan off in full.
You have to pay taxes on property you own, including your house and the land upon which it sits. The local municipality in which your land lies collects these taxes each year.
In addition to your mortgage payment, you may also have to pay homeowner’s association fees if you live in a planned development. These charges vary according to where you live. Sometimes, your homeowner’s association fees are part of your mortgage payment. Most often, however, these fees are separate from your mortgage payment and are due on a quarterly or annual basis.
You will also need to budget for maintenance costs for your new home. When you are a renter, your landlord takes care of maintenance costs. But, as a homeowner, you will be responsible for maintaining your home. There are two typical ways to estimate how much you need to set aside for maintenance. One method is to set aside one percent of the purchase price of your home every year for maintenance. The other method is to set aside one dollar per square foot of your home. Either method will give you a bit of a cushion when you need to do some home repairs.
What are the variables to consider when calculating your mortgage payment?
When you are looking at the way your mortgage payment breaks down, variables to consider are the interest rate and the term of your loan. For instance, you may have a fixed interest rate that will never change for the entire time you have the mortgage. Or, you may have an adjustable rate, which can change once or more in the time you are paying your mortgage.
Your loan term is the length of time for which you will make payments. Typical mortgage loan terms may be 15, 20, or 30 years.
What is amortization?
Amortization refers to the process of repaying a loan through structured payments. When you get your mortgage loan, your lender will provide you with an amortization schedule, which is simply a table that breaks down the amount of your loan payment applied to principal and the amount applied to interest for each scheduled payment. Typically, in the first several years of your loan, you will see that your payment is mostly applied to interest. As you continue to make payments, however, more and more of your payment goes toward paying down your principal balance. As you pay down your principal balance, you are building equity in your home.
What is escrow, and how does it work?
Many lenders require that your monthly mortgage payment must include annual property taxes and your annual homeowner’s insurance premium. This means that a portion of your payment each month is set aside in an escrow account. When your taxes and homeowner’s insurance payments are due, your lender takes the money from the escrow account and forwards it to your municipality and insurance company.
This is a handy service that your lender provides for two reasons. First, it ensures that your insurance and taxes are always current, which benefits you and your lender. Second, it is convenient for you, since it keeps you from having to come up with additional lump sums of money when those amounts are due.
SuperMoney Tip: Never allow your bank or lender to choose your homeowner insurance. Mortgage lenders don’t care what insurance covers the home. If you leave the choice to lenders, they will simply go with the insurance company they partner with. Only you, the buyer, knows whether a policy is affordable and offers adequate coverage.
You will receive an escrow statement from your lender annually so that you can see the exact allocation of your payments. The statement will also tell you exactly how much your tax and insurance bills are and their payment status.
How do you calculate what your mortgage payment will be?
While it is possible to calculate your mortgage by following a formula, you might want to take the easier route and use an online mortgage calculator. Here are the figures you will need to plug into online mortgage calculators to get a good ballpark estimate of what your monthly mortgage payment will be:
- The appraised value of your home.
- The principal loan amount.
- The interest rate.
- The term of your loan (expressed either as years or months).
- The amount of your property tax annually.
- The amount of your homeowner’s insurance annually.
- Once you have these numbers, simply plug them into your online mortgage calculator and the calculator will generate an approximate monthly payment amount. Many online mortgage calculators will generate an amortization schedule for you as well.
Of course, to get the actual amount of your monthly mortgage payment, you will need to consult your lender, who will provide you with loan disclosure statements that clearly show your monthly mortgage payment amount.
Can your mortgage payments go up?
Unlike a personal loan or car loan, your mortgage payment can change over time. This makes perfect sense when you consider the methods used to calculate your mortgage payment.
For instance, consider your escrow items. Your homeowner’s insurance premium and your tax amount may change several times in the course of a 30-year loan. And each time these amounts go up or down, an adjustment in your payment occurs to accommodate the change.
Additionally, if you have an adjustable rate loan, your interest rate may go up or down as well, which will have a corresponding effect on your total monthly payment.
After you have built up 20 percent equity in your home, you will no longer have to pay PMI, which may lower your monthly payment.
Factors that you control may also change your payments over time. For instance, if your lender allows you to make additional principal-only payments, you will end up paying less in interest than you would have paid otherwise, and this may affect your monthly payments.
Can you lower your monthly mortgage payment?
If you calculate your projected mortgage payment and you do not like what you see, there are some things you can do to lower your payment. For instance, you might consider coming up with a larger down payment. This would affect both the principal balance and the amount of interest you would have to pay each month. And if your down payment is at least 20 percent, you can avoid paying PMI altogether, which will lower your payment as well.
Let’s take an example of how this would work using the mortgage calculator provided online by Zillow. In this scenario, your home value is $200,000. You have a fixed interest rate of 4 percent. Your annual property taxes are $2400 and your annual homeowner’s policy premium is $800.
If you pay $20,000 down, your monthly payment would be $1,215. This amount includes $859 for principal and interest, $89 for PMI, $67 for homeowner’s insurance, and $200 for taxes.
However, look how things change when you make a larger down payment. Suppose you put down $40,000 instead of $20,000. Your new monthly payment would be $979, which includes $712 for principal and interest, $67 for homeowner’s insurance, and $200 for taxes.
The more you pay up front, the lower payments you will have. You can experiment with online mortgage calculators to find out how much you would need to pay down to get a mortgage payment you can afford.
By changing the variables like down payment, interest rate, or loan terms, you can quickly see big differences in your monthly payment as well as in the overall cost of your mortgage.
How can you find the best mortgage loan?
When the time comes for you to find the home of your dreams, it is a good idea to get a mortgage loan preapproval before you go house-hunting. A mortgage company can often help you find the right lender with the right type of loan for your situation. You can find the best mortgage companies here.