You’re thinking about buying a house, but you aren’t sure what your mortgage loan (or monthly payment) will look like. You can easily imagine yourself in your brand-new home — you have the furniture all picked out for your reading nook and know exactly how you want your kitchen to be laid out…but the idea of figuring out how to pay for it feels overwhelming. Still, to make your dream a reality, determining how to estimate a mortgage loan and how much you can spend is something you’re going to have to do.
A house is likely going to be one of the biggest purchases of your life, so it’s important to make your process as painless as possible, especially the financial aspect. To make it a little easier, and with follow-along math, we’re mapping out the steps you should take to estimate a mortgage loan and understand how much house you can afford.
What is the price you’ll pay for the house?
This might or might not be the same thing as the list price or asking price — and it might or might not be the same as your offer price! It’s the amount that you and the seller agreed upon for the house after negotiations are over and the dust has settled.
If you’re trying to estimate the cost of a mortgage loan in advance of shopping for a home, you’ll need to start and run through this exercise a few times, adjusting the price of the home up or down depending on whether the final numbers are feasible for you or not.
You can follow along with our numbers, using $300,000 and $125,000 as our home price for consistency throughout the examples.
How much are you putting down?
Your down payment will have a big impact on your mortgage loan estimate because it directly affects your monthly payments and even your interest rate. It can also affect whether or not you’ll need mortgage insurance.
You’ll want to subtract this amount from the total sales price because the down payment is your contribution to purchasing the house, so the lender won’t need to give you a loan to cover the full sales price because you’re covering some of it.
A down payment is usually expressed as a percentage of the purchase price, so make sure you’re converting that % back into whole dollars when you do the math for this calculation.
Your down payment can vary. First-time buyers often think that 20% is standard for a down payment, but that’s not true. There are many mortgage programs that offer you the ability to put down far less — even nothing in certain cases!
If you need to have a smaller down payment, see if you meet the criteria for any of the following loan programs:
- FHA loans can be approved with just 3.5% as a down payment.
- Conventional loans can be approved with as little as 3% as a down payment.
- USDA loans are available mostly in rural areas and enable buyers to put down zero percent of the price.
- VA loans enable eligible active duty military personnel and veterans to buy a home with zero percent down.
Remember that your down payment percentage has a big impact on your mortgage loan overall and your monthly payments, so opting for a low or no down payment may not necessarily be your best option unless your budget can accommodate higher monthly mortgage payments.
What is your loan amount?
This will be the sales price (minus the down payment amount) and is a very easy number to calculate.
For example, if your sales price is $300,000 and your down payment is 3% (which is $9,000), then your loan amount is $300,000 – $9,000, which is $291,000.
If you’re buying the same $300,000 home, but you’re putting down 15% (which is $45,000), then your loan amount is $300,000 – $45,000, which is $255,000.
If your sales price is $125,000 and your down payment is 3% (which is $3,750), then your loan amount is $125,000 – $3,750, which is $121,250.
If you’re buying the same $125,000 home, but you’re putting down 15% (which is $18,750), then your loan amount is $125,000 – $18,750, which is $106,250.
Will you need to pay mortgage insurance on the loan?
If you put down less than 20%, you may need to pay mortgage insurance (MI) for a period of time, which is based on the loan amount.
Mortgage insurance protects lenders in the event that you stop making payments on your loan, so expect your lender to require it if your down payment is less than 20% on a conventional loan, or if you’re taking out a FHA loan (regardless of down payment amount).
Your mortgage insurance amount will depend on various factors, including the amount of your down payment, your credit score, and which state the home is in.
Different banks and lenders have different ways of calculating this, but you can safely calculate your mortgage insurance rate to be somewhere between 0.25% and 1% of your mortgage loan amount annually. It will be split up and included in your monthly mortgage payments.
If you use a conventional loan, you can opt out of mortgage insurance once you own 20% of the home’s equity, so paying for mortgage insurance may be a short-term expense, depending on your home’s price and relative down payment. For FHA loans, however, the mortgage insurance typically lasts for the lifetime of the loan, unless you make a down payment of 10% or higher.
Are you getting an ARM or an FRM?
Adjustable-rate mortgages (ARMs) start with lower initial interest rates, which then are adjusted with the market periodically after the introductory period. These can be a great option if you don’t plan to stay in the home very long, or when the market rate is high but is expected to decrease before the introductory period ends. These are not a great option when market rates are very low and likely to increase after the introductory period, especially if you are planning on living in the house for many years.
Your interest rate with a fixed-rate mortgage (FRM) won’t change over time, which means your payment amounts are the same throughout the life of the loan. These are a great option when market rates are low and are expected to rise over the duration of the mortgage.
What is your loan term?
“Loan term” is a fancy way of saying “how long will you have to pay back the loan?”
Mortgages are usually repaid in 30-year or 15-year increments, but you may be able to get a loan for other terms if you like.
There are benefits to both longer and shorter loan terms. Shorter terms mean higher monthly payments but less spent overall on the loan. Longer terms give you more time to pay and lower monthly payments, but also more spent overall on the loan in interest.
Not everyone can be approved for a shorter-term loan, as the monthly payments will be higher, but your income remains the same. Depending on how much you want to spend on a house, a longer loan term may be your only loan term option.
As an example, paying off a $100,000 loan over 30 years would mean a $278 principal payment each month. Paying off the same $100,000 loan over 15 years would mean a $555.56 principal payment each month. If your total budget to repay this hypothetical loan is $500 per month, then a 15-year loan term isn’t feasible.
(As a note, neither of these example numbers include interest, which can also vary based on your loan term.)
How many payments will you make on the loan?
Your loan term will determine the number of total payments you make on a loan. Typical numbers are 360 for a 30-year loan or 180 for a 15-year loan, as most loans are paid on a monthly basis.
To save you from having to get out a calculator:
- 30 years x 12 months per year = 360 payments
- 15 years x 12 months per year = 180 payments
What is your interest rate?
When calculating your monthly payments, you’ll want to look at the interest rate rather than the annual percentage rate (APR) because your monthly payments will not reflect your closing costs. You’ll use your APR when calculating the overall cost of the loan.
It’s important to shop around for the best interest rate available to you for the type of loan you’re considering. Know that factors like your loan term, type of mortgage, down payment percentage, and credit score will all have an impact on your interest rate.
Do you want to do the math yourself?
If you want to do the math yourself, the formula you’ll need to follow is:
M = P [ I (1+I) ^ N ] / [ (1+I) ^ N – 1]
In this formula:
- P is your loan principal, the total amount of money you borrowed (the loan amount)
- N is the number of payments you will make on the loan
- I is your interest rate
Let’s work through this using:
- P = $291,000 from the example above,
- N = 180 payments for a 15-year loan
- I = 4% interest rate for simplicities’ sake, which would be .04 / 12 months per year for the monthly interest rate and equal .0033
The first part of the equation becomes:
P [ I (1+I) ^ N ] = 291,00 [.0033(1+.0033) ^ 180)
And the second part of the equation becomes:
[ (1+I) ^ N – 1] = [(1+.0033) ^ 180 – 1]
We’ll be following PEDMAS, which is
- Division &
For our order of operations in the formula.
First, we’ll look into the innermost parentheses to calculate 1 + I, which in this case is 1 + .0033 = 1.0033
Next, we calculate N-1, which in this case is 180 -1 = 179
^ is “to the power of,” so we have some exponential multiplication to do here:
P [ I (1+I) ^ N ] = 291,00 [.0033(1+.0033) ^ 180] = 291,000[.0033 x 1.0033 ^ 180]
[(1+I) ^ N – 1] = [(1+.0033) ^ 180 – 1] = [.0033 x`1.0033 ^ 180-1]
M = 291,000 [.0033 (1+.0033) ^ 180 ] / [(1+.0033) ^ 180 – 1] = $2,146 payment each month
For a 30-year mortgage term, the only number that would change would be I to 360 monthly payments.
This would make the formula, (with the changes in bold):
M = 291,000 [.0033 (1+.0033) ^ 360 ] / [(1+.0033) ^ 360 – 1] = $1,389 payment each month
If you can plug all the numbers in correctly, you’ll wind up with your estimated monthly payments — but you can always use an online calculator, too! An online calculator is simple and quick to use and has the added benefit of being a bit more accurate. Running the same examples through an online calculator results in monthly payments of $2,152 for a 15-year mortgage, and $1,389 for a 30-year. (This is a good idea if you just want the end result and not have to look at some terrifyingly big numbers along the way.)
Remember that this formula does not include taxes, mortgage insurance, or homeowners insurance, which are additional costs that will factor into your monthly mortgage budget. Without them, your estimate could be seriously off and potentially result in a mortgage you can’t really afford.
Is there a prepayment penalty? How much, if so?
Always ask if there is a prepayment penalty. Even if you don’t think you’re likely to pay off your mortgage early, ask!
It’s good information to know so that you don’t wind up penalized for paying your mortgage off early. The last thing you want is a financial penalty for paying off a debt.
If you can’t avoid a prepayment penalty on your best mortgage option, know how much it is so you can calculate whether it’s worth taking the hit at a later date if you end up being in a position to pay off your mortgage early.
What else goes into a mortgage payment?
We’re not done yet. There are a few more items you need to factor into your mortgage payments.
As a homeowner, you’re going to be responsible for property taxes. These can vary wildly, depending on where you live, but the average American household spends $2,471 on property taxes for their home every year. Your property taxes can be as low as 0.28% if you’re in Hawaii, as high as 2.49% if you’re in New Jersey, and somewhere in between if you’re in the rest of the United States.
Two good options for learning what property taxes in your area are like are to
- Ask your agent or lender
- Call up the tax assessor’s office in the county where the house is located
Richard Helali, mortgage sales leader at HomeLight Loans, explains that you can’t necessarily use what the current homeowners are paying for property taxes to calculate your tax burden on the same house, but it depends on the state you’re in.
“For example, in California when someone buys a home, the clock resets, and now that person is going to pay the tax rate based on the price of what they bought it for. So there have been folks that said, ‘My taxes are going to be $2,000 a year because that’s what the current homeowners pay’, and we do the math, and it’s actually going to be $6,000 to $7,000 a year based on the price they’ll be paying.”
Some states determine rates by using tax assessments that can be done on a yearly or every-third-year basis, some use the home’s market value, and others use the appraisal value. Make sure to find out how your local property taxes are calculated, and understand how that could affect your monthly payment.
Like your taxes, the cost of having homeowners insurance will depend on the value of your home and where it’s located.
According to Insurance.com, the national average in 2021 for a $300,000 home with a $1,000 deductible and $300,000 of liability is $2,305 per year. That’s about $190 per month.
If you live in Hawaii, you’ll pay well under the average and closer to $499 per year (or about $42 per month) for the same coverage. In Oklahoma, you’ll pay well above the average at around $4,445 per year (or about $370 per month).
Of course, there are several factors that go into calculating your homeowner’s insurance cost, so the best thing to do is to speak with an insurance agent directly and get a more solid estimate.
You can start by calling the company that is providing your current renter’s or car insurance. If you don’t have either of those insurance policies, you can always ask your buyer’s agent if they have any insurance agents they recommend to their clients in your position.
Sometimes HOA fees
Homeowners associations (HOAs) are common and are increasing in popularity in neighborhoods comprising single-family homes. If your house is located in a neighborhood with an HOA, make sure you know what the HOA dues are, how often they’re collected, and what the dues cover as far as neighborhood maintenance and access to amenities.
Be sure to examine the covenants, conditions, and restrictions (CC&Rs) of the HOA to see how they may impact your ability to implement any changes you have planned for the house.
HOA fees can range from between $100 and $1,000 per month, depending on amenities, so glossing over them can drastically throw off your mortgage budget. If you’re unsure what the potential impact HOA fees may have on your mortgage, Helali advises calling up your loan officer and giving them the hard numbers. They’ll be able to provide advice specific to your situation.
How can I reduce costs on my mortgage estimate?
If your mortgage estimate feels a little overwhelming, don’t panic! There are things you can do to reduce costs on your mortgage estimate.
Improve your credit
One of the best things you can do is find ways to improve your credit, which will get you a better mortgage interest rate from the lender. You can do this by reducing other debts or removing errors on your credit report, among other strategies.
Save up more for a down payment
As mentioned above, a bigger down payment can reduce your interest rate and loan amount, remove the need for mortgage insurance, and overall reduce your monthly payments.
Look into first-time buyers assistance programs
If you qualify as a first-time buyer, meaning you haven’t owned a home in the past three years, you may be able to tap into first-time buyer assistance, either as down payment assistance or help with closing costs. Any money you were planning on using for closing costs could then be added to your down payment.
Some programs are nationwide, and others are local to your area, so explore all the options and see what you qualify for.
Shop around for loans!
Different lenders have different rates and fees. It may be a good idea to go first to lenders who have already extended you a line of credit.
For example, your lender for your car payments may offer you a better rate because you have a long history of on-time payments.
Estimating a mortgage loan might seem intimidating, but once you’ve taken this important step, you’ll be able to figure out how much to save … and sooner or later, start shopping for your first house!
Header Image Source: (Marta Matwiszyn / Unsplash)