Understanding Your Mortgage
When shopping for a mortgage to buy a home, it is important to have a clear view of the numbers and what they mean, since it will likely be the largest bill you pay every month. Eighty-eight percent of home purchasers will make a down payment and finance the rest of the purchase with a mortgage through a bank or other financial company.
The interest rate you pay on the amount financed depends on economic conditions at the time of purchase and can increase or decrease daily until you lock your rate in. Even a seemingly small change in the interest rate will greatly affect the total amount of interest you pay.
Conventional wisdom says that you put down 20 percent of the purchase price and finance the rest, but there are other options that allow a smaller (or no) down payment, such as U.S. Department of Agriculture, Federal Housing Administration, or Veterans Affairs loans. Note that when putting less than 20 percent down, private mortgage insurance (PMI) will likely be required.
Research each mortgage option to see which one works best for you. A realtor can help guide you to the best choice for your particular situation.
Every dollar paid for the down payment is equity that you have in the home and one more dollar that you will not have to pay interest on; however, home equity is illiquid, meaning that it does not convert into cash easily. (See liquidity in the glossary.)
The two most common repayment terms for mortgages are 15 and 30 years. With a 15-year loan, you have a higher payment each month but pay the home off in half the time. A 30-year mortgage ties up less of your monthly income but costs much more in interest over the life of the loan.
For example, on a $150,000 loan at 4 percent interest, a 30-year mortgage payment would be $716.12 (plus escrow), costing a total of $107,804.26 in total interest. With all else equal on a 15-year mortgage, the monthly payment would be $1,109.53 (plus escrow), costing a total of $49,715.74 in interest. This is not considering that you usually get a lower interest rate on a 15-year mortgage. Most mortgages offer the ability to pay more than is required without penalty, lessening the length of amortization (the time it takes to pay off the loan). In the above 30-year mortgage scenario, paying an extra $100 per month over the life of the loan would save you $25,205.87 in interest!
When coming up with a down payment, remember that you will have fees at closing that will likely be in the thousands of dollars. These can include prepaid interest, prepaid insurance, prepaid taxes, administration fees, appraisal fees, inspection fees, attorney fees, title fees, realtor fees, and more. These are referred to as closing costs.
The estimated monthly payment you get at closing will not be your payment for the life of the loan. The cost of insurance and taxes will change, adjusting the monthly payment. This is especially true if you are building a new home, as your estimated taxes may be based on the land only; once your property is reassessed in the next year with the home, the taxes due will increase significantly.
Figuring Your Costs
You probably want an idea of what your monthly payment or total interest would be on a proposed mortgage. If you have access to Microsoft Excel, you can run the numbers to find out. Open Excel and search for “amortization schedule” in the templates section. You may have to click “more templates,” or the search bar may be on the opening page, depending on your version of Excel. Open the Excel template named Loan Amortization Schedule (the file can also be found here).
You’ll replace the default information with your own details. Let’s go cell by cell to get your information as correct as possible:
- Loan amount: This is the amount that you are borrowing from a financial institution. Do not include any down payment or closing costs.
- Annual interest rate: This is the interest rate for the money you are borrowing.
- Loan period in years: Over how many years will you pay the loan? The most common mortgage terms are 30 and 15 years.
- Number of payments per year: For nearly all mortgages, this will be 12 (one payment per month).
- Start date of loan: Put in the date of your first payment. In most cases, this will be 2–6 weeks after closing.
- Optional extra payments: To begin, change this to zero. Once you enter all your information, you can see how much extra payments will save you in total interest.
- Lender name: You can put the name of your lender here, although it will not affect the mortgage numbers in any way.
Under the loan summary section, you will get the following information once you enter values:
- Scheduled payment: This is how much the monthly payment will be for the principal and interest of your mortgage. It does not include the cost of insurance and taxes. Make sure that you get an estimate of these two costs from an insurance company and your local tax office.
- Scheduled number of payments: This is how many total payments you will make, assuming that you make no extra payments over the life of the loan.
- Actual number of payments: If you pay more than the minimum on the loan, then this will show how many fewer payments that you will make.
- Total early payments: This is the total dollar amount of your early payments.
- Total interest: This is the total amount of interest that is paid over the life of the loan.
Below the Enter Values and Loan Summary sections, you will see an amortization schedule. You can see the proportion of each payment that will go to principal and to interest, along with your ending balance due after each payment and the total amount of interest paid to date. Any extra payments you make will adjust the numbers in the schedule accordingly.
Amortization: The process of paying off a loan with regular payments over time. The fixed payments include both the principal and the interest on the loan, with the interest charges becoming smaller and smaller over the payment schedule.
Closing costs: The fees paid to complete a real estate transaction. Closing costs usually equal about 3 percent of the sale price.
Down payment: An upfront payment of a portion of the total price of an item. A down payment reduces the amount of money you need to borrow.
Escrow: The money your bank (or an escrow company) collects and holds to pay taxes, insurance, and other costs associated with the mortgage.
Equity: The value of an asset after subtracting the amount owed on the asset.
FHA loan: A mortgage insured by the Federal Housing Administration.
Finance: Borrowing money to pay for a large purchase.
Insurance: A policy paid for by the borrower that is intended to protect against financial loss.
Interest: The cost of borrowing money.
Liquidity: The ease with which an asset can be converted to cash.
Mortgage: A loan from a bank or financial institution that helps a borrower purchase a house.
Principal: The amount due on a loan not including interest.
Private mortgage insurance (PMI): The amount paid to the lender to insure the mortgage for the lender.
USDA loan: A mortgage insured by the U.S. Department of Agriculture.
VA loan: A mortgage insured by the U.S. Department of Veterans Administration.
Bankrate. (2019). Glossary. https://www.bankrate.com/glossary
Bankrate. (2017, December 15). Should you pay cash for a house? https://www.bankrate.com/mortgages/should-you-buy-a-home-with-cash/
The information given here is for educational purposes only. References to commercial products, trade names, or suppliers are made with the understanding that no endorsement is implied and that no discrimination against other products or suppliers is intended.
Publication 3365 (POD-05-19)
By Andy Collins, Extension Instructor, Extension Center for Technology Outreach.
Copyright 2019 by Mississippi State University. All rights reserved. This publication may be copied and distributed without alteration for nonprofit educational purposes provided that credit is given to the Mississippi State University Extension Service.
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Extension Service of Mississippi State University, cooperating with U.S. Department of Agriculture. Published in furtherance of Acts of Congress, May 8 and June 30, 1914. GARY B. JACKSON, Director
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