When making a real estate purchase, one of the largest factors that will determine whether or not you purchase a property is the amount of the monthly mortgage payment. Oddly enough, many buyers do not know exactly how to calculate the amount of the mortgage.
While your real estate agent and/or lender should be able to provide an estimate of the monthly mortgage payment, it is a good idea for you to know how those figures are calculated. This article breaks down the components of the mortgage payment, the typical amount of each component, and how the information can be obtained and determined.
The Components of the Mortgage Payment
Most websites that offer a mortgage payment calculator only calculate the principal and interest portions of the payment. In fact, the entire mortgage payment is typically comprised of principal, interest, taxes, and insurance, commonly referred to as PITI.
To calculate the amount of your mortgage, you will need to know:
The principal amount of the loan;
The interest rate of the loan;
The term of the loan (the number of months for your mortgage);
The annual amount of property taxes;
The annual premium for hazard insurance;
The annual premium for mortgage insurance (if applicable).
Let’s say that you have a 30-year, $200,000 mortgage at an interest rate of 6%. Annual property taxes are $3,000 and the annual hazard insurance premium is $500. The annual mortgage insurance premium is $1,000. In word form, the monthly mortgage payment is calculated by multiplying the present value of the loan principal amount by the monthly interest rate (6% divided by 12 months) for a term of 360 months (30 years). This results in the principal and interest portion of the payment. To easily calculate the payment, I usually use Microsoft’s Excel program and use the “PMT” (payment) formula.
Once you have the principal and interest portions of your payment, add the following to the payment: monthly amount due for property taxes, monthly amount due for hazard insurance, and monthly amount due for mortgage insurance. All monthly amounts can be calculated by dividing the annual amounts by 12. This makes up your complete mortgage payment.
The principal amount is the actual portion of the loan that is being repaid, while interest is the fee you pay to the lender for the use of their money. The interest on a mortgage is usually expressed as an annual percentage of the principal. It is important to note that the amount of interest is usually the largest part of the mortgage payment. The amount of interest paid is usually reduced as the loan amortizes. More of your payment then goes towards the principal amount of the loan.
The taxes that are included in your mortgage payment are the property taxes that are due annually, as assessed by your county of residence, while hazard insurance is the protection on your home in case of random “hazards” (i.e. break-ins, fire, earthquakes, etc). Depending on where your home is located, you may also be required to obtain flood insurance for your property (this is usually separate from the standard hazard insurance policy). Additional insurance that could be required as part of your monthly mortgage payment is private mortgage insurance (PMI) or a mortgage insurance premium (MIP). This insurance is usually required if the loan-to-value ratio for your home loan is more than 80%.
Please note that some people will tell you that taxes and hazard insurance are optional portions of the mortgage payment. This is true with some lenders. In this case, you would just pay principal and interest (and mortgage insurance, if required) to them, but you are responsible for paying your own taxes and hazard insurance when they are due. However, most lenders will require you to pay a portion of taxes and insurance monthly as part of your mortgage payment. This is because the lender wants to ensure these items are paid on time in order to mitigate the risk to their asset (your home that you have pledged as collateral for the funds that you’ve borrowed).
When taxes and insurance are included as part of your monthly mortgage payment, the lender places these payments in an escrow account and disburses the funds as the bills are due. This is advantageous to the borrower since you won’t have to worry about coming up with the funds at the end of the year to pay your property taxes and hazard insurance-especially if you are not as disciplined to set aside the funds yourself throughout the year.
How to Obtain the Information to Determine Your Monthly Mortgage
The principal and interest amounts for your loan are pretty easy to find. This information is included in your loan documents if you have already secured a loan and know the interest rate of the loan.
The amount of your property taxes can be estimated by looking at the last tax bill. This is always an estimate, as the tax value of your property can be adjusted annually, depending on the state and county in which you live. The rate at which your property is taxed can also change; therefore, the last tax bill is a good indicator of what to expect going forward.
Hazard insurance is determined by your insurance company, and depends on various factors including the age of the home, whether or not you have a security system, and the proximity of your home to a fire hydrant, just to name a few. Like car insurance, it pays to shop around for hazard insurance. Usually, the company that you have your car insured with will offer a discount for your home insurance.
Mortgage insurance is determined by the insurer and usually varies, depending upon whether you have a conventional loan (which is insured by a private company), or a loan backed by the Federal Housing Association (FHA) or Veterans Association (VA), for FHA and VA loans, respectively. This factor of the mortgage payment is the least readily determinable in advance, but the annual premium should not amount to more than 0.75% of the principal amount of your mortgage.