How to Calculate Your Monthly Mortgage Payments
When buying a home, it's important to calculate the monthly mortgage payments and then compare them to your monthly budget. You do have a home-buying budget, don't you? For the sake of this article, I'll assume you already have a budget in place, and that you're now ready to calculate your monthly payments for a home loan.
We will get to the "how" of this article in just a moment. But first, let's talk about why it's important to go through this process.
Why This Process is Important
In 2008 and 2009, we saw more home foreclosures than ever before in our nation's history. There were many reasons for this financial fiasco, but the primary reason has to do with monthly mortgage payments in relation to the homeowner's income. Many first-time buyers simply took on loans that were too big for them. They didn't take the proper steps needed to determine their affordability level. In other words, they failed to establish a budget for themselves and marched blindly into the home-buying process. The rest, of course, is history.
This is what happens when you don't calculate your monthly mortgage payments in advance. The size of the loan is obviously important, but the monthly payments are even more important in the short term. If your payments exceed the amount of money you earn each month, you will eventually default on the loan -- and possibly end up in foreclosure.
When to Calculate Payments
We just discussed the reasons why it's important to calculate your monthly payments on a mortgage loan. Now let's talk about when you should take this important step.
Some home buyers start talking to mortgage lenders before they even have a budget established. This is backward, and it's the kind of mistake that can lead to a foreclosure scenario. You need to establish a monthly budget for yourself long before you start applying for loans and talking to lenders. This is one of the most important concepts of this entire article, so I'm going to repeat it:
Before you apply for a loan or calculate mortgage payments, you should establish a monthly budget / spending limit for yourself. You would do this by comparing your monthly debt payments to the amount of money you bring in each month (after taxes). Here's an article that explains how to do that.
Once you have a budget established, you can move on to the next step and actually calculate the monthly payments on a particular mortgage loan. In other words, you can take a hypothetical price of a home, and use a mortgage calculator to reduce it into monthly payments. Then you can compare this monthly amount to the budget you've already created, and determine if that particular price falls within your comfort zone. You would need to do this for every house you consider along the path.
These are the steps a smart home buyer will take when purchasing a home and applying for mortgages:
- Find out how much you make and spend each month.
- Based on the above comparison, establish a monthly spending limit for your mortgage.
- Use mortgage calculators to divide the price of a home into monthly payments.
- Compare those monthly payments to the maximum amount you can spend each month toward a home.
- Never exceed your budget when obtaining a mortgage loan -- this is a recipe for missed payments, credit score damage, and possibly even foreclosure.
The Parts of a Mortgage Payment
Before we go any further, we need to discuss the various components that make up your monthly mortgage payment. The rest of this article will make a lot more sense once you understand these components. There are four primary ingredients that make up your monthly payment, and they are collectively referred to by the acronym PITI. This acronym stands for principal, interest, taxes and insurance.
- 'P' stands for the principal amount that you are borrowing. This is the overall loan amount minus the interest.
- 'I' stands for the amount of interest you are charged on top of the principal. The interest rate will vary based on your credit score, current lending trends, and other factors.
- 'T' stands for the taxes you pay on the home. These are commonly referred to as property taxes, and they are usually rolled into the monthly mortgage payment on the loan.
- The second 'I' stands for insurance. This is the homeowners insurance policy you must have in place before you can close on the home.
When you combine all four of these elements, you have a monthly mortgage payment amount. Of course, some elements weigh more than others. The principal amount borrowed plus the interest will determine most of your monthly payment amount. But the taxes and insurance play a role as well (albeit a lesser role).
Using a Monthly Payment Calculator
Now that we've discussed the four components that make up a monthly mortgage payment, we can talk about how you would calculate such a payment (based on a particular loan amount). At a minimum, you need to have two of the four components listed above -- the principal and interest. Without these two factors, it doesn't make any sense to calculate monthly payments because the results won't be very accurate.
If you have an idea of what you'll be paying in taxes and insurance, then your calculation will be even more accurate. But you can calculate the monthly payment even without these two items, and you'll still be in the ballpark of reality.
So, you need to know the principal amount borrowed and the interest rate on the loan. When you have these two things, you can plug them into a monthly payment calculator to find out whether a particular home falls within your comfort zone.
Let's look at an example:
Let's say I'm considering a house that costs $225,000. I have a down payment of $25,000, so that means I'll need a mortgage loan of $200,000 to cover the remainder. That is my principal loan amount (or the 'P' in the PITI acronym).
Now let's assume that I get pre-approved by a lender, and they tell me I'm qualified for an interest rate of 5.5%. Now I have another component of the PITI acronym -- I have my interest rate. As we discussed earlier, these are the two items we need, at a minimum, if we want to calculate the monthly mortgage payment on the loan. If I know (A) how much I'm borrowing, and (B) what kind of interest rate I can get, then I can use a monthly payment calculator to see what I might be spending each month.
You can find these calculators all over the web, and they perform a wide variety of functions. But for the purposes of this exercise, all you need is a basic mortgage payment calculator. These tools will take your principal loan amount, apply the interest rate to it, and then display your monthly payments. You can find some good calculators at Bankrate.com and many other financial websites. You can also do a Google search for the phrase "mortgage payment calculator," and you'll find plenty of them.
So, let's revisit the mortgage scenario I started earlier. I need to borrow a principal amount of $200,000, and the mortgage lender has told me I qualify for an interest rate of 5.5%. Those are the two elements I'll need to use a payment calculator. So I plug these numbers into the tool, and it calculates my monthly mortgage payment in the following way:
- Principal: $200,000
- Term: 30 years
- Interest: 5.5%
- Monthly Payment = $1,135
Summary and Conclusion
Let's talk about some of the key points we covered in this lesson. First, we talked about the importance of establishing a monthly budget for yourself, before you start talking to lenders and applying for loans. This should always be the first step to the mortgage process. Many first-time buyers skip this step, and it usually creates problems for them down the road.
Once you have an idea what you can afford to spend each month, you can start talking to lenders and perhaps even get pre-approved for a mortgage loan. This is when the lender reviews your financial situation and tells you (A) how much they're willing to lend you, and (B) what kind of interest rate you qualify for.
When you reach this stage of the game, you can start to use mortgage calculators to calculate the monthly payments you may incur. In order to use such a calculator, you will need at least two of the four PITI elements we discussed earlier. You will need to know the principal loan amount you're borrowing, as well as the interest rate that's going to be applied to the loan. With these two items, you can calculate a particular loan amount for a house and break it down into monthly payments. Then you would compare these payments to the monthly budget you established earlier, and you could find out if a particular house was inside or outside of your financial comfort zone.
I've hit you with a lot of information in this article, but you can see that the process is really not that complicated. There are just a few key steps you must go through to make a smart buying decision.
I hope you enjoyed this lesson on how to calculate monthly mortgage payments, and I wish you all the best in your home buying process. If you have other questions about this topic, be sure to do a search with the box provided at the top of this website. There are more than 2,000 home buying and mortgage articles on this website, so you're bound to find the information you need.