Elements of your mortgage payment
Now that you know the types of mortgage payments, what are all the expenses you need to consider when buying a home?
1. Closing costs
Buying a house is an exciting time, but it can also add up quickly. Closing costs are often a surprise if you’re not paying attention.
Typically, the home buyer pays for things like mortgage fees (including the loan origination fee, loan discount fee and loan application fee), mortgage insurance, credit report and mortgage broker fee. The seller will pay real estate commission and the property taxes equivalent to the amount of time they spent in the house that year.
Other closing costs to watch out for includes homeowner’s insurance, title insurance, document recording fees like your home’s deed, a property appraisal and a payment cushion for escrow items, which is typically two months of your mortgage payment.
There’s also a down payment on the principal. Usually, this payment is about 3-7% of the total principal. However, if you can pay 20% of the home’s down payment when you purchase, you can avoid paying private mortgage insurance (PMI), which is an additional required expense until you’ve paid off 20% of your mortgage.
2. Principal
Unless you pay for your house entirely in cash upfront, you’re borrowing money from a lender to make the purchase. Your principal payment is the total amount you borrow with your mortgage. You’ll see what your principal is before you close, as well as when you’re making your monthly payments.
With most fixed-rate loans, you’ll pay the same amount of money each month, though your principal will slightly go up as you pay more off your loan. You can also add money to your principal payment each month, as well.
For example, if your mortgage payment is normally $2,200 and you instead pay $2,500 each month, a portion of that $2,200 will go to your principal, and the entire amount of that extra $300 will go toward your principal. It’s a way to potentially pay off your mortgage even quicker, though don’t feel like you have to overpay if it would put you in a financial strain.
3. Interest
The interest rate is determined by current market rates and the level of risk the lender is taking on to lend you money. If you have a higher credit score, that can help lower your interest rate. You’re required to pay interest with your principal payment each month.
As you go through the life of your mortgage, your monthly interest payments will go down slightly. Let’s say that after all of your closing costs and down payments, your principal is $300,000 with a 4% interest rate. Your annual interest rate would equal $12,000 (300,000 x .04). That first interest payment would be $1,000, the monthly equivalent of the annual rate.
However, as your mortgage goes on, the interest payment would drop because the total principal is also decreasing. By the time your remaining principal was at $125,000, that 4% interest rate would instead be $5000 annually, or $416.67 for the interest portion of your monthly payment. In turn, more of your monthly payment would go toward paying down your principal.
That example applies to a fixed-rate mortgage. However, if you have an ARM, your monthly payments are less predictable, since the interest rates fluctuate.
4. Taxes and insurance
You’ll also need to pay property taxes and home insurance on any house you buy. These are typically an annual expense, but to avoid having a massive sum once a year, most lenders will increase your monthly payments and put the excess money in an escrow account.
Your escrow account generally consists of a two-month “cushion” of payments. When it’s time to pay your taxes and insurance, the lender simply withdraws the money from the escrow fund. Your lender will periodically reevaluate your escrow account and make adjustments if need be.
For instance, if property taxes in your area rise, or something happens that requires your insurance to cover you, you may see an increase in those costs, and thus, a higher escrow payment each month. Those increases are reflected on your total monthly payment.
Occasionally, an escrow may cover other costs, but taxes and insurance are the most common.
Buying a home is a major accomplishment. Though the closing process and mortgage payments can appear to be overwhelming, with some research, preparation, and patience, you’ll come out the other side looking great and be set up for success throughout your mortgage.
