Understanding how your mortgage payment is figured is important if you want to be able to make an informed decision about which type of mortgage is right for you. Here are some of the things to consider as you compare apples to apples when it comes to different mortgage options:
Types of mortgages
First of all, it’s important to understand that there are different types of mortgages. The type of mortgage you choose can influence what interest rate you end up with, ultimately determining how much you pay in interest for your loan.
Your mortgage interest rate is set by a process that involves a number of factors from current market conditions to your credit situation to the type of mortgage you get. It’s important to choose a mortgage program that meets your needs.
The best long-term results often come from 15-year fixed-rate loans, since you don’t have to worry about rising loan rates, or resetting loan terms if you have a low teaser rate, or an interest-only loan. Often, what seems like an affordable loan initially, due to a low variable rate, or the fact you are only paying interest to start, suddenly becomes unaffordable when the initial loan period of three, five, seven, or 10 years is over.
What mortgage fees can you expect to pay?
You should also realize that your mortgage fees might be rolled into your mortgage payment each month. In fact, many monthly mortgage payments consist of more than just your principal and interest. You can also expect to pay homeowners insurance premiums and property taxes as part of your monthly payment.
Other fees might be rolled into your mortgage loan as well. If you have closing costs, loan origination fees, and other costs, they might be added to the loan balance, and you could end up paying interest on the new balance. When comparing loan options, you also need to shop around with different lenders and look at mortgage fees. In some cases, you might see a lower APR, but by the time higher fees are factored in, the loan could actually end up costing more.
Pay attention to the fees associated with each loan; then, decide whether it makes more sense to pay the fees up front, rather than adding them to your loan balance. Also, make sure you understand how paying insurance and taxes, on top of your regular principal and interest payment, affects your monthly total payment. For example, if property taxes increase, your monthly payment will go up, since you will owe more in taxes, even though your principal payment won’t change. This can also be the case if your homeowners insurance premium increases, requiring you to pay a little more each month.
Calculating your APR and monthly mortgage payment
APR stands for “annual percentage rate.” This is the rate, expressed as a percentage of the amount you borrow, that you will pay each year. Your APR should include “financing charges” as part of the amount charged, as well as any fees or additional costs to the loan. Make sure that you check with your lender to find out what is included in your APR, since different lenders include different items as “financing charges.”
Your monthly interest paid is based on your APR. So, if you have an APR of 3.75%, your monthly interest rate is divided by 12 (since there are 12 months in a year). In this case, your monthly interest charge would be 0.3125% of your monthly balance. It’s also important to remember that, when figuring your mortgage payment, you also need to consider how many payments you will make total. So, a 30-year loan has 360 payments total, while a 15-year loan has 180.
When calculating your monthly mortgage payment, you use the following formula for a fixed-rate mortgage: M = P [i(1 + i)^n] / [(1 + i)^n - 1]
In this equation, P = the principal, i = the monthly interest, and n = the number of payments to be made.
It looks so complicated because the formula includes the fact that a mortgage involves compound interest, so you are figuring that you will pay interest on your interest each month. Additionally, the formula has to take into account the fact that your balance will decrease each month as you make your payments. If you get a 30-year loan for $200,000 with an APR of 3.75%, and plug in the numbers, it would look like this:
M = 200,000 [0.003125(1 + 0.003125)^360 / [(1 + 0.003125)^360 - 1] = $926.23
Of course, this equation only provides you with information about your payment when you have a fixed rate, and it only includes your principal plus interest. You need to add other monthly costs to your payment as well. If you pay $50 a month for homeowners insurance and $100 a month for property taxes, that will add another $150 per month to your payment, for a total monthly payment of $1,076.23.
If you have a variable interest rate, your mortgage payment will be refigured each time your rate is adjusted, which might be every quarter, semi-annually, or annually. This can change your mortgage payment regularly, as can regular increases in property taxes, or changes to your homeowners policy premiums.
Don’t forget that special financing arrangement can also have an impact. If you have an interest-only loan, your mortgage payment might only be $625.00 per month to start. However, you won’t be paying on your principal, so you won’t be making a dent in your loan balance. When you have to start paying on your principal as well, you can experience a much higher monthly payment. If you chose a loan based on the “affordability” of that interest-only payment, then you could be in serious trouble when your new payment is outside your ability to pay.
For many homebuyers a fixed mortgage rate is preferable because it is easy to see what you will pay each month (at least in terms of principal and interest) for the entire loan, and better plan for it. Before you get a home loan carefully consider the impact of your mortgage payment, and take the time to understand what goes into your monthly costs. It’s almost always more than you expect.
