Annual Income: the total current yearly earnings of those taking out the mortgage. If a married couple is taking out the mortgage, the income figure will be their combined annual income. Note: the income figure is only what you are earning now, not reflecting any future earning increases or decreases. If you are self-employed or paid on commission, the mortgage lender will probably want to take the average of your last two years of income.
Interest Rate: the interest rate quoted on the mortgage. The calculator lets you specify between 1% and 18% (though you will almost certainly not get either such a low or such a high interest rate). The calculator assumes you are applying for a traditional fixed-rate mortgage, not an adjustable rate mortgage (ARM) or interest-only mortgage.
Term: the amount of time you will be making payments, assuming you don't make additional payments to pay down the mortgage earlier. The term is determined at the time you take out the mortgage. The calculator lets you select from 1 to 30 years. (Thirty years is the most common term traditionally.)
Down Payment: amounts you will pay against the principal at closing. Mortgage lenders have traditionally required a down payment as a sign of creditworthiness, and also to provide them with a safety cushion in the event the borrower defaults.
Monthly Debt Payments: amount you are paying on average each month toward car loans, education loans, credit card debt, and other debt. The calculator only allows you to select a single amount for the sake of simplicity. In reality, of course, your debt may increase or decrease over time, but the lender will likely want the average amount you are paying toward debt now.
Annual Property Taxes: the total amount you would have to pay in property taxes on the property you want to buy in one year, at the current tax rate and assessed value. Over time, this amount will change as property taxes and/or the assessed value changes, but the mortgage lenders' formula only asks for the current year's amount.
Annual Home Insurance: the amount you will pay each year on homeowner's insurance and private mortgage insurance. The homeowner's insurance covers damage to the home and theft; policies can be more or less generous and usually cost more or less depending on coverage. Mortgage insurance is a kind of life insurance that will pay any outstanding mortgage payments if the owner dies. Mortgage insurance is entirely optional and many people choose just to get enough life insurance to cover the mortgage payments as well as other expenses.
Closing Costs: the costs of transacting the sale of the home and the mortgage. Closing costs come down to origination fees and points. Origination fees cover the paperwork of the loan, fees for home inspections and deed search, other miscellaneous costs and points. Most lenders advertise their mortgages as having various combinations of points and interest rates. (Ex. 5.25% plus 1 point) A point is equal to 1% of the selling price. So if you are paying 3 points on a $100,000 home, you would pay $3000. You pay points as part of your "closing costs" (what you must pay when you actually sign legal contracts with the lender and seller to make the house yours). Usually the lower the interest rate, the more points will be required.
A mortgage is a loan from a bank, credit union, or mortgage company that uses the property you are buying as collateral.
Qualifying for a Mortgage
Banks, credit unions, and mortgage companies don't want to make mortgages to people who will default, so they have set up hard and fast rules for determining whether an applicant for a mortgage will be able to make all the payments. The rules look not only at an applicant's income and the price of the house, but at a number of costs associated with the house and a number of factors in an applicant's ability to pay.
Costs associated with homeownership (explained in more depth in the next section):
- Property Taxes
- Mortgage Interest
- Closing Costs
Note that there are other costs of homeownership that are not considered when banks decide whether to qualify an applicant for a mortgage. However, you should consider these costs when deciding how much you can afford. These "soft" costs include one-time costs such as those of furnishing a new home and moving house. There are also costs you will have to pay for the life of the home, such as:
In general, if you are moving to a larger home, expect all of these "soft" costs to be higher than where you are living now. If you have been renting a home where water and/or utilities are included, remember these costs as well. If you will moving farther away from work and also remember the increased commute costs. If you're driving to work, increased commute costs include not only the increase in fuel used, but wear and tear on the car.
Types of Mortgages
There are various types of mortgage programs available, though the calculator, to keep things simple, assumes you are applying for a traditional fixed-rate mortgage.
- A fixed rate mortgage has a set interest rate for the life of the loan. It doesnít change no matter how much interest rates may go up or down. A fixed rate mortgage has consistent payments for principal and interest.
- The interest rate on an adjustable rate mortgage can go up and down with the prime rate. This means that your monthly payment may also fluctuate over the life of the loan.
- Interest-only mortgages are true to their name: you only pay the interest on the principal, and none of the principal itself. Obviously, your monthly payments upfront will be lower (since you're not paying principal), but if you get a regular mortgage at the end of the interest-only mortgage, your total costs from both the interest-only and regular mortgages will likely be far higher than if you had been paying principal all along.
- There are also special mortgages to help you own your home. Some of them are through the Veterans Administration, Federal Housing Administration, or the Rural Housing Service. State and local governments back loans for first-time borrowers and some non-profit agencies offer down-payment assistance.
Mortgage Payments: What's Inside
Mortgages can have various terms of repayment: 15, 20, 25 and 30 years. They are paid monthly. When you make a monthly mortgage payment, you are really making three payments:
- Principal: the money you actually borrowed. This can be any amount up to 90% of the selling price, depending on your lenderís requirements.
- Interest: a percentage of the principal, the amount you are paying to the lenders to use their money to buy your house. This percentage remains the same for the life of your loan if you have a fixed rate mortgage. If you have an adjustable rate mortgage, the percentage can go up or down at various intervals. There are caps on how much up or down your interest rate can change. These will be spelled out in your mortgage contract so pay close attention to what you are signing. (Articles on both types of mortgages are available on this website.)
- Escrow: funds collected to pay your: (1) property taxes; (2) homeowners insurance, and (3) private mortgage insurance, if applicable. Not all lenders collect an escrow amount. Some expect the borrowers to put aside funds for taxes and insurance on their own. No matter what, you have to pay these costs, so be sure to take them into account. Also remember that property taxes and insurance costs can, and likely will, go up over time.
The monthly payments cover costs over the life of your mortgage. But there are additional costs associated with actually getting the mortgage in the first place.
- Origination fees to pay for the paperwork of the loan, fees for home inspections and deed search, other miscellaneous costs and points.
- Points. Most lenders advertise their mortgages as having various combinations of points and interest rates. (Ex. 5.25% plus 1 point) A point is equal to 1% of the selling price. So if you are paying 3 points on a $100,000 home, your would pay $3000. You pay points as part of your "closing costs" (what you must pay when you actually sign legal contracts with the lender and seller to make the house yours). Usually the lower the interest rate, the more points will be required.