10-Step Guide to Financing Your Dream Home
Step #5 – Understand Your Monthly Mortgage Payment
Return Tomorrow for Step #6
Your Mortgage Payment Explained
As a renter you are used to sending your landlord a monthly payment, which sometimes even includes your utility payments.
Once you become a homeowner, your monthly mortgage payment becomes more complicated.
Unless you are paying cash for your home, you will have a mortgage payment. There are typically four parts to this monthly mortgage payment, often referred to as PITI:
- Principal: This is the portion of your payment that goes to pay down the balance that you borrowed. If you opt for a fixed-rate loan, your monthly payment will not change over the loan term, but the makeup of your payment will change. In the early years of your loan, you mostly pay interest, but gradually you will begin to pay more of the principal. For example, in the first month of a 30-year fixed-rate loan of $200,000 at 4.5%, your payment will be $1,014 with $264 toward principal and $750 toward interest. In 20 years, the payment will still be $1,014 each month—but the payment will be shifted to $647 toward principal and $367 toward interest.
- Interest: The interest you pay is the cost of borrowing money.
- Taxes: Your lender usually requires an escrow account and will collect one-twelfth of your annual property tax bill in this account with each mortgage payment.
- Insurance: You will pay one year of homeowners’ insurance premiums at your home settlement as part of your closing costs, and then your lender will collect one-twelfth of your annual insurance premium in this account with each mortgage payment. While most lenders require you to pay your homeowners’ insurance this way, some offer you the option to pay the insurance company directly rather than include it in your monthly bill.
- If you make a down payment of less than 20%, your mortgage payment may also include mortgage insurance, a fee you pay that protects your lender in case you default on the loan.
While there are sometimes exceptions to the rule, lenders generally require your house payment to be 31% or less than your gross monthly income. So when you are calculating how much you can afford to spend on a home, you should keep that figure in mind.
Other Housing Expenses
If you buy a condominium or a home within a homeowners association (HOA), you will also need to pay association dues. These dues are not part of your mortgage payment but will be considered as part of your debt-to-income ratio. Condo fees are usually collected monthly, and HOA fees can be collected monthly, quarterly or annually.
When you are making up a housing budget, you also need to estimate your utility costs—which you will pay separately from your mortgage. You can ask the sellers of a home you’re interested in for their average utility bills. Don’t forget you may need to pay not only gas and electric bills but also a water bill and possibly a trash removal fee.
As a renter, you’ve been able to call your landlord when an appliance breaks or you have a plumbing leak, but as a homeowner these problems will become yours. You need to budget for maintenance and repairs, but it can be difficult to predict what issues will arise in any particular year.
It also depends on the age and condition of your home. A home inspector can give you an idea of when you might need to replace particular appliances, but you can also keep about 1% of your home value available for emergency home repairs.
Budgeting for homeownership is a key element to maintaining your ability to keep your home and to help it hold onto its value. Making your monthly house payment is the biggest part of the financial commitment—but certainly not the only one.