Understanding How Mortgages Work and Calculating Your Monthly Payments
July 25, 2024
1 min read
Understanding How Mortgages Work and Calculating Your Monthly Payments
Purchasing your first home is a big milestone, it’s the largest purchase of most people’s lives! One question we get asked often by our members is, “How much home can I afford?”
How Mortgages Work
Mortgages are loans sold by financial institutions that allow borrows to buy a home. When you take out a mortgage, the home itself serves as collateral for the loan. Mortgage loans are typically taken out to cover the different between what a buyer is putting down as a down payment and the sale price of the home.
What Are You Paying For In Your Monthly Mortgage Payment?
Monthly mortgage payments will consist of four main components: principal, interest, taxes, and insurance (often abbreviated as PITI).
1. Principal: This is the amount of money you borrowed from the mortgage lender to purchase the home.
2. Interest: This is the cost of borrowing money from the lender, expressed as a percentage of the loan amount - this is what we know as the mortgage interest rate, which can vary based on the loan type. In 2024, the 30-Year Fixed Rate Mortgage has hovered between 6.75 and 7.25%.
3. Taxes: Property taxes are assessed by local governments and are typically paid as part of your monthly mortgage payment. This is typically between 0.5 and 2% of the property’s value per year.
4. Insurance: Mortgage insurance, including homeowners insurance and, if applicable, private mortgage insurance (PMI) or mortgage insurance premium (MIP) for FHA loans, are included in the monthly payment. PMI is required for mortgages that represent more than 80% of the home value (down payments under 20%). PMI rates are determined based on the loan-to-value ratio, based on the borrower’s credit score, and of course, based on the home price. PMI is typically paid out in the monthly mortgage payment as a monthly premium and will usually range from 0.3% to 1.5% of the principal loan amount annually.
Inputs That Determine Your Monthly Mortgage Payment
Several key inputs determine what your monthly mortgage payment will be:
1. Loan Amount: The total amount of money borrowed to purchase the home, which is usually the purchase price minus the down payment.
2. Interest Rate: The annual percentage rate (APR) at which the loan accrues interest.
3. Loan Term: The length of time over which the loan will be repaid, typically 15 or 30 years.
4. Property Taxes: The annual property taxes assessed by the local government.
Calculating Your Monthly Mortgage Payment
To calculate your monthly mortgage payment, you can use the following formula:
M = P [i(1 + i)^n] / [(1 + i)^n - 1]
Where:
M = monthly mortgage payment
P = principal loan amount
i = monthly interest rate (annual interest rate divided by 12)
n = number of months over which the loan will be repaid
For example, let's calculate the monthly mortgage payment for a $400,000 loan with a 4% interest rate and a 30-year term.
P = $400,000
i = 4% / 12 = 0.00333
n = 30 * 12 = 360 months
M = 400000 [0.00333(1 + 0.00333)^360] / [(1 + 0.00333)^360 - 1]
M ≈ $1,909.66
You can use online mortgage calculators like ours at Foyer to quickly estimate your monthly mortgage payment based on these inputs. Additionally, keep in mind that if you opt for an FHA loan, there may be additional factors to consider, such as upfront mortgage insurance and annual mortgage insurance premiums, which can influence your monthly payment.
Down Payment on a $400,000 House
The down payment on a $400,000 house is a crucial consideration when applying for a mortgage. The down payment amount will directly impact the loan amount, the need for mortgage insurance, and, in turn, your monthly mortgage payment.
As described above, a down payment below 20% will require private mortgage insurance for conventional loans, but first time hombuyers can put down as little as 3% on conventional loans, 3.5% on FHA loans, or even 0%, depending on what types of grants and first time homebuyer programs there are available in your state.
Credit and Home Affordability
Your credit score plays a significant role in the mortgage application process. A higher credit score can lead to a lower interest rate, which, in turn, can reduce your monthly mortgage payment. A credit score of 800+ will get you the most competitive mortgage rate. Conversely, a lower credit score may result in a higher interest rate and, consequently, a higher monthly payment. Typically, a credit score of 580 or higher is required to take out a mortgage at all, and many First Time Homebuyer programs, like this one in GA, require a credit score of 620 or higher.
FHA Loan vs. Conventional Loan
FHA loans are backed by the Federal Housing Administration and are designed to help lower-income and first-time homebuyers. These loans often require a lower down payment and may be more accessible to individuals with lower credit scores.
On the other hand, conventional loans are not backed by the government and typically require a higher down payment and stricter credit requirements. However, for those who do meet the criteria, conventional loans can offer more flexibility in terms of loan terms and mortgage insurance options.
In conclusion, understanding how mortgages work and the factors that determine your monthly mortgage payment is essential for anyone considering purchasing a home. By carefully assessing these inputs, including the loan amount, interest rate, down payment, credit score, and the type of loan, you can make informed decisions about your home purchase and achieve greater financial stability. Remember to consult with a mortgage professional to discuss your specific situation and explore the options available to you.
Whether you’re still trying to figure out what your ideal home price is or you’re actively shopping mortgage rates, Foyer can help you maximize your savings and buy your first home with confidence.
