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Understanding Mortgage Payments
What is a Mortgage Payment?
A mortgage payment is the amount of money a homeowner pays each month to their lender to repay the loan used to purchase their home. This monthly payment typically includes several components: principal, interest, taxes, and insurance, commonly referred to as PITI. Additionally, if your down payment is less than 20% of the home's purchase price, you may need to pay for private mortgage insurance (PMI).
Are you just starting to consider buying a home? Knowing what you can afford can be difficult before your lender approves your loan—understanding how the PITI elements of a mortgage payment work is crucial for managing your finances effectively. Calculating your PITI will also ensure an accurate deal analysis for cash flow if you buy an investment property.
If you need help finding a lender, BiggerPockets can point you in the right direction: Our free Lender Finder can find investor-friendly lenders specializing in funding your unique real estate strategy.
Types of Mortgages and Home Loans
Conventional Loans
A conventional loan is a mortgage that is not guaranteed or insured by any government agency, including the Federal Housing Administration (FHA) or the Department of Veterans Affairs (VA). It is typically fixed in its terms and rate. Conventional loans are often favored by borrowers with strong credit histories and stable financial backgrounds, as they can offer competitive interest rates and flexible loan terms.
Adjustable-Rate Mortgage (ARM)
Adjustable rate mortgages (ARMs) allow borrowers to pay lower interest rates on their loan for a set period, after which the rates will change. For example, a 7/1 ARM means that the borrower's interest rate will remain fixed for 7 years—and after this initial period, the interest rate adjusts annually. ARMs are particularly attractive to borrowers who plan to sell or refinance their home before the fixed-rate period ends, as they can benefit from the lower initial interest rates.
Fixed-Rate Mortgages
Fixed-rate mortgages have a consistent total monthly payment for principal and interest. Over time, the composition of these payments changes due to amortization. Initially, a larger portion of the payment goes towards interest. As more principal is paid off, the interest component decreases, and more of the monthly payment contributes to the loan balance. Fixed-rate mortgages can be especially beneficial in a low-interest-rate environment, allowing homeowners to lock in a favorable rate for the loan term.
Federal Housing Authority (FHA) Loans
An FHA loan is a mortgage insured by the Federal Housing Administration. It is especially popular among first-time home buyers because it allows down payments of only 3.5% for credit scores of 580 or higher. While FHA loans have lenient credit score requirements and low down payment allowances, borrowers must pay additional mortgage insurance premiums, which protect the lender if a borrower defaults.
HomeReady Loan
HomeReady mortgages are a line of conventional home loans offered by Fannie Mae to help low- and moderate-income borrowers buy or refinance. HomeReady mortgages allow for a down payment as low as 3%, which can be a significant advantage for those who may not have substantial savings. The program permits income from non-borrower household members to be considered in the loan application, which can help applicants qualify for a larger loan amount.
Hard Money Loan (HML)
A hard money loan is an asset-based loan typically issued by private investors or companies. These loans are often used for short-term financing, especially in real estate transactions. They are popular among real estate investors who need quick access to capital for property purchases, renovations, or to bridge financial gaps. Due to their higher risk, hard money loans usually come with higher interest rates and shorter loan terms, making them more expensive than traditional loans.
Veteran Affairs Loan (VA)
VA-guaranteed loans are offered by private lenders, such as banks or mortgage companies, to eligible veterans to purchase a home that must be used as their residence. The guarantee protects the lender from loss if the borrower or a subsequent owner fails to repay the loan. These loans provide significant benefits to veterans, including no down payment requirement, competitive interest rates, and limited closing costs.
Personal Loans
A personal or private mortgage is a loan made by an individual or business that is not a traditional mortgage lender. Private mortgages can offer more flexibility than conventional loans, as they often have fewer bureaucratic hurdles and can be tailored to fit the unique needs of both the borrower and the lender. However, it's crucial to carefully consider the terms of a private mortgage, as they may include higher interest rates or shorter loan terms compared to traditional loans.
Factors Affecting Mortgage Payments
Home Price and Down Payment
The price of the property and down payment are two significant factors that affect your mortgage payments. The home price determines the loan amount you need to borrow, while the down payment affects the loan-to-value (LTV) ratio. A higher down payment leads to a lower monthly payment because it reduces the loan amount.
Private mortgage insurance (PMI) is typically required for borrowers who make a down payment of less than 20% of the home's purchase price. This insurance is designed to protect the mortgage lender in case the borrower defaults on the loan. PMI is generally calculated as a percentage of the original loan amount and is added to the monthly mortgage payments. Once the borrower's equity in the home reaches 20%, they can typically request the removal of PMI , potentially reducing their monthly payments.
Mortgage Rate and Loan Term
Lower interest rates reduce monthly mortgage payments and total loan costs. With lower rates, more of your payment goes toward the principal rather than interest. Additionally, the mortgage term impacts monthly payments and interest paid: longer terms (like 30-year mortgages) mean lower payments but more total interest, while shorter terms (like 15-year mortgages) offer higher payments with less overall interest and quicker equity buildup.
What is the Formula Used to Calculate Monthly Mortgage Payments
The variables of a mortgage payment formula are:
- Principal (P): The amount of money borrowed from the lender.
- Interest Rate (i): The percentage of the principal charged by the lender for borrowing the money. It is usually expressed as an annual percentage rate (APR), but for mortgage calculations, it is divided by 12 to get the monthly interest rate.
- Loan Term (n): The time over which the loan is to be repaid. It is usually expressed in years, but for mortgage calculations, it is converted to the total number of monthly payments.
- Monthly Mortgage Payment (M): The amount of money that needs to be paid each month to repay the loan.
For those of you who like crunching numbers instead of using our handy mortgage calculator, the formula looks like this:
What Are The Costs of a Mortgage Payment?
To get more specific about what the costs are in a mortgage, here's what each cost means:
- Principal:This is the money you borrowed to buy the property. Each mortgage payment reduces the principal amount owed.
- Interest:This is the cost of borrowing money from a lender. The interest rate is determined by several factors, including your credit score, the size of your down payment, the type of mortgage you choose, and the macroeconomic environment.
- Property taxes:These are taxes that your local government assesses on the value of your property. In many cases, your mortgage lender will collect these taxes as part of your monthly mortgage payment and pay them on your behalf through an escrow account. Property tax rates can vary depending on location and are calculated as a percentage of your home's value, funding local services.
- Homeowner's insurance:This is insurance that protects your property against damage or loss. Your lender may require you to purchase homeowner's insurance as a condition of your mortgage. Homeowner's insurance is critical in determining your monthly mortgage payments, as it protects both the property and the homeowner's liability.
- Private Mortgage Insurance (PMI): If you make a down payment that is less than 20% of the purchase price of your home, your lender may require that you pay for private mortgage insurance. PMI protects the lender in case you default on your loan.
- Escrow account:Mortgage lenders use escrow to manage and pay expenses such as homeowner's insurance and property taxes on behalf of the borrower. This ensures an organized approach to covering necessary costs associated with homeownership, making it a critical component of monthly mortgage payments.
- Homeowner's association fees: If you live in a neighborhood or community with a homeowner's association (HOA), you may be required to pay monthly or annual HOA fees . These fees cover the cost of maintaining common areas and amenities like pools or parks.
How Our Mortgage Calculator Helps
Our online mortgage calculator can be extremely helpful if you want to purchase a home or refinance an existing mortgage. With this tool, you can input the home price, down payment, loan term, interest rate, and property taxes to quickly and easily determine your monthly mortgage payments.
In addition to our primary calculator, we offer various mortgage calculators for affordability, debt-to-income ratios, and specific loan types. These tools are essential for potential buyers and those considering refinancing, as they help evaluate different financial scenarios and make informed decisions.
This can be especially useful if you compare different mortgage options and want to see how different factors affect your overall costs. With our BiggerPockets mortgage calculator, you can make informed decisions about your home financing and ensure you get the best deal possible.
How to Reduce Your Monthly Mortgage Payments
Reducing your monthly mortgage payment can lighten the financial load of homeownership, making it more manageable in the long run. Here are some tips on how you can reduce your monthly mortgage payment:
- Refinance: Refinancing involves taking out a new loan to pay off your existing mortgage, often with a lower interest rate or longer loan term. By refinancing, you can take advantage of a lower interest rate and reduce the interest you pay over the life of the loan. However, weighing the costs of refinancing against the potential savings is essential to ensure it makes financial sense for you.
- Make a larger down payment: A larger Refinancing involves taking out a new loan to pay off your existing mortgage, often with a lower interest rate or longer loan term. By refinancing, you can take advantage of a lower interest rate and reduce the interest you pay over the life of the loan. However, weighing the costs of refinancing against the potential savings is essential to ensure it makes financial sense for you.
- Buy down points: When you buy down points, you pay an upfront fee to your lender to reduce your interest rate over the life of the loan. This can help you save money on interest and lower your monthly mortgage payment. However, weighing the costs of buying down points against the potential savings is vital to ensure it makes financial sense. If you plan to sell or refinance the property in the near future, the initial cost of buying down points may not be worth the potential savings.
By using these strategies, you can reduce your monthly mortgage payment and make the process of paying off your mortgage more affordable and manageable.
Frequently Asked Mortgage Questions
What Is a Refinance?
How Do I Get a Mortgage Loan?
What Is a Fixed-Rate Mortgage?
What Is an Adjustable Rate Mortgage?
What Is a PITI Calculator?
What Are Points on a Mortgage Loan?
When Is the First Monthly Payment Due?
Which Mortgage Option Is Best for Me?
What Does My Mortgage Payment Include?
What Happens After I Am Pre-Approved?
What Credit Score Do I Need for a Mortgage Loan?
What Documents Do I Need for a Mortgage Loan?
What Is the Difference Between Pre-Qualified & Pre-Approved?
Explanation of terms
Interest rate
The interest rate is the percentage of the loan amount that the lender charges the borrower for borrowing the money. It is expressed as an annual percentage rate (APR) and represents the cost of borrowing the funds. The interest rate can be either fixed, meaning it remains constant over the life of the loan, or adjustable, meaning it can change based on market conditions or specific terms outlined in the mortgage agreement.
Loan period
The length of time the borrower has to repay the mortgage in full. This period is typically expressed in years, with standard loan terms being 15, 20, or 30 years. The loan term affects the size of the monthly payments and the total amount of interest paid over the life of the loan. Generally, a longer loan term results in lower monthly payments but a higher total interest cost, while a shorter loan term leads to higher monthly payments and a lower total interest cost.
Down payment
An upfront payment made by the borrower when purchasing a home. It represents a percentage of the home's total purchase price and serves as the borrower's initial equity stake in the property. The down payment reduces the loan amount the borrower needs to finance through the mortgage. Generally, a larger down payment results in lower monthly mortgage payments and can help the borrower qualify for more favorable loan terms, such as a lower interest rate. Standard down payment amounts range from 3.5% to 20% of the home's purchase price, depending on the type of mortgage and the borrower's financial situation.
PMI (Private Mortgage Insurance)
Private Mortgage Insurance (PMI) is a cost incurred by borrowers with a loan amount exceeding 80% of the home price. It is necessary for high-risk loans, particularly when the borrower has a down payment of less than 20%. PMI is calculated based on the loan amount and the borrower's credit score, and it can significantly impact monthly mortgage payments. The insurance protects the lender in case the borrower defaults on the loan.
Use of this calculator signifies your agreement to our Terms of Use and the terms posted below.
The calculators found on BiggerPockets are designed to be used for informational and educational purposes only, and when used alone, do not constitute investment advice. BiggerPockets recommends that you seek the advice of a real estate professional before making any type of investment. The results presented may not reflect the actual return of your own investments. BiggerPockets is not responsible for the consequences of any decisions or actions taken in reliance upon or as a result of the information provided by these tools. Furthermore, BiggerPockets is not responsible for any human or mechanical errors or omissions. BiggerPockets obtains property details from various third-party sources, and BiggerPockets is not responsible or liable for the accuracy, completeness, or suitability of the property details. You are responsible for confirming the property details are accurate, complete, and suitable for your use case.
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