If you’re preparing to purchase your first home, you’re probably scratching your head more than you anticipated. Between the complex terminology and variety of home loan options, the home-buying process can become confusing rather quickly.
One area that first-time homebuyers struggle the most to understand is their monthly mortgage payment. Unlike a car loan, it’s not as clear-cut. And most real estate websites and financial calculators only focus on the principal and interest portion of your payment – which can be very misleading.
Before you get your hopes up and realize that the house you’ve been eyeing is out of your price range, take a moment to familiarize yourself with the components of a mortgage payment.
Principal & Interest
Whether it’s a car loan, credit card, or student loan, your monthly payment will consist of principal and interest.
Principal: The amount of money you borrow from the lender. You must repay the total amount over a specified time period.
Interest: Money that you pay to the lender in exchange for them lending you money. This amount is repaid on top of the principal balance.
Calculating the principal and interest portion of your mortgage payment is pretty simple. For example, assume you plan to purchase a $300,000 house using a 30-year fixed-rate mortgage at 4.5% APR. Plug those figures into any loan calculator, and you’ll get the following:
Loan Amount $300,000
Interest Rate (Fixed) 4.5% APR
Term 30 Years
Principal & Interest (Monthly) $1,520.06
Your monthly payment, in this example, would be $1,520.06. The problem with this scenario is that a large chunk of your actual monthly payment is missing from this figure. There is more to your monthly mortgage payment than just principal and interest.
Variable Components of a Mortgage Payment
As a homeowner, you’ll be responsible for other recurring expenses. The two most common costs are property taxes and homeowner’s insurance. Instead of requiring homeowners to pay these larger bills all at once, they are usually broken up and included in your monthly payment – then stored in an escrow account.
An escrow account is money held by a third party and disbursed as needed to the proper organizations or vendors. For example, the escrow portion of your mortgage payments will be placed in a separate account managed by a third party. When your property taxes are due, they will make the payment on your behalf.
Before reviewing how these variable costs can impact your monthly payment, it’s important to know the most common types, so you’re not caught off guard.
Homeowner’s Insurance: Lenders typically require you to carry a homeowner’s insurance policy on your property. This protects your home in case of theft, fire, etc.
Property Taxes: Annual taxes levied by the county and state on your property.
Homeowner’s Association Dues: Depending on where you live, you might have a homeowner’s association. Sometimes these are inexpensive and will be billed to you directly. Other times, such as living in a townhome or condo, these fees include maintenance and amenities – making the cost more expensive. If that’s the case, they may be escrowed to help you cover the annual expense.
Private Mortgage Insurance: Some lenders will require homebuyers to carry private mortgage insurance (PMI) if they don’t make at least a 20% down payment when buying the home. PMI protects the lender should you default on the loan.
Variable Components in Action
To illustrate how these variable costs will impact your monthly mortgage payment, review the following example.
Homeowner’s Insurance $2,000
Property Taxes $3,000
Homeowners Assoc. Dues $1,200
Private Mortgage Insurance $1,500
Total Variable Costs $7,700
Instead of requiring you to make a $7,700 payment at once, these costs can be broken up over the year and added to your monthly mortgage payment. So, the $7,700 payment over 12 months becomes $641.67 per month.
Now, bring back the original principal and interest portion of your monthly payment, and your actual payment comes to light.
Principal & Interest Payment $1,520.06
Variable Costs $ 641.67
Actual Monthly Payment $2,161.73
You can see how first-time homebuyers, unaware of these variable costs, can easily be misled by mortgage calculators on real estate websites. They tend to leave out crucial information that impacts your real monthly payment.
Before you begin looking at homes, it’s always wise to sit down with your lender and at least run some preliminary numbers. That way, you know what you can afford before you begin your house-hunting journey.
We’re Here to Help!
Buying your first home is both exciting and scary. It’s a significant financial investment, and you want to ensure you’re making the right decisions along the way. If you have any questions about financing your new home or the home-buying process, we’re here to help.
Please stop by any of our convenient branch locations or call (248) 745-3353 to speak with a member of our Mortgage team today.
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