Your Monthly Payment Includes More than the Mortgage
How much mortgage can you afford? Keep in mind that your mortgage is only one part of your monthly expenses for a new house.
Paying everything by the month
There are usually four components that go into your monthly payment: Principal, interest, taxes, and insurance–often referred to as PITI.
- Principal. Principal is the amount you originally borrow. Early in your mortgage’s term, your payments will be applied mostly to the loan’s interest. As the loan progresses, you’ll pay off more principal.
- Interest. Interest is money the lender charges to take the risk on your loan. The interest rate on your loan has a direct correlation to the size of your payment. That is, a higher interest rate leads to higher monthly payments. For most homebuyers, higher interest rates reduce the amount of money they can borrow, and lower interest rates increase it.
- Taxes. Property taxes can account for a significant amount of your monthly payment. These taxes for local schools, city and county services, and other local entities are based on the tax rate for each of those taxing authorities and the appraised value of your property. Instead of a large tax bill coming due at the end of the year, many people pay their property tax as part of their monthly payment. The annual amount is divided by the total number of payments in a given year. The lender collects these payments and holds them until they are due, at which point, the lender uses the money to pay the bill.
- Insurance. There are two types of insurance coverage that may be included in your monthly payment. The first type, property insurance, protects your home and possessions from fire, theft and other events your policy outlines. The second type of insurance is private mortgage insurance (PMI). When a homebuyer does not put down at least 20% on the home, most lenders require PMI. PMI offers the lender some protection in the event the borrower is unable to repay the loan. PMI coverage can be dropped once you attain 20% equity in the home.
Taking responsibility for taxes and insurance
While these four components make up a typical monthly payment, some lenders allow homeowners to pay taxes and insurance on their own. In this scenario, you’ll have a lower monthly payment, but you must make sure you have the money available to pay property taxes and insurance when those bills come due. This requires discipline.
Amortization breaks it out
An amortization schedule shows how much of your monthly loan payment is being applied toward interest costs and how much to reduce the outstanding balance of your loan. The amortization chart details the month-by-month progression of your mortgage payments from mostly covering interest to mostly covering principal. Many lenders allow you to pay extra each month to pay off principal early and pay less interest over the length of the mortgage.
Add it up
So, how much mortgage can you afford? Factor in the principal, interest, taxes, and insurance to get a true picture of the cost of a home. Your REALTOR® can be a great resource to help you understand these components plus other costs of homeownership.
Source: Texas Association of REALTORS®