mortgage calculator how it works

What is a Mortgage Calculator? How it Works and its uses.

Finance Loan

What is a Mortgage Calculator?

A mortgage calculator is a type of automated tool that helps users get an estimate of their monthly mortgage payment. You can enter a different home price, down payment amount, interest rate and loan term to find out how your monthly payment changes according to that. 

A potential borrower can use a mortgage calculator to find out their borrowing capacity, a mortgage lender can compare a home buyer’s total monthly income and total debt intake capacity. A mortgage calculator helps add up all income sources, your credit score, down payment, etc. to come out with an estimated monthly mortgage payment. 

 

What’s included in a mortgage loan calculator?

A mortgage loan calculator has the following basic heads for input:

  • Your home price
  • The amount you put into the down payment
  • Mortgage loan term
  • Interest Rate

Some calculators go a step further and also take in your credit score range, zip code, and HOA fees which gives you a more accurate payment estimate. This way you get a better picture of your mortgage payments and can purchase with added confidence.

 

The Math behind Our Mortgage Calculator/Equation for mortgage payments

Here is the formula that is used for calculating mortgage payments is as follows:

M = P [ i (1 + i) ^ n ] / [ (1 + i) ^ n – 1]

Where the variables are as given below:

  • M stands for the monthly mortgage payment.
  • P is the Principal Amount taken in the mortgage loan.
  • i is the monthly rate of interest. Most mortgage lenders list the interest rates as an annual figure, so you would require to divide it by 12 to find the monthly interest rate. For instance, if your interest rate is 5%, then the monthly rate would be 0.05/12 = 0.004167.
  • n is the number of payments you need to make over the loan tenure. So, if you take a 30-year fixed-rate mortgage loan as an example- that means n = 30 (years) x 12 (months) = 360 payments, in total. 

You just need to put in the values in this formula to get an estimate of how much loan you can afford. You will also get to know if you are putting down enough money or not. You can adjust your figures based on the estimate given by a mortgage calculator. 

 

How to use a mortgage payment calculator?

The mortgage calculator will have several heads and you have to enter relevant information under them. Enter the purchase price (if you are buying a home) under “Home Price” or the current value of the house, if you are refinancing. Enter the down payment amount under the “Down Payment” head or the equity amount (if you are refinancing). Under the “Interest rate”, enter your mortgage interest rate. Adjust the mortgage term under “loan term” and then the calculator will give you an estimate of your monthly mortgage payments.

Some mortgage calculators also provide you with the privilege of entering the property taxes, homeowners insurance and homeowner’s association fees, etc. A mortgage calculator also allows you to compare different loan types. You could also get your amortization schedule to get an idea of how the principal balance, equity (principal paid) and the total interest paid, change over the loan period. 

 

Home Price

You can adjust your house price in the calculator and see how the monthly mortgage payment changes. This will help you get an idea of your house affordability. This input depends on your monthly income, debts, credit scores and down payment savings. The thumb rule states that you should opt for a mortgage loan when your DTI ratio (Debt-to-income) is roughly 36% or less. Higher the ratio, the less likely it is for you to be able to afford the loan.

DTI = (total monthly debt payments / gross monthly income) x 100

 

Down Payment

Down Payment is the amount of money you pay, for the house you are purchasing, before leaving the rest amount to be taken care of by a mortgage loan. For example, if you pay 20% of the purchase price of the house, then 80% of the purchase price will be your mortgage loan and 20% will be known as your down payment.

Lenders deem 20% to be a standard down payment, but that is not quite the real-life scenario. Most borrowers can put down an amount in the range of 10% to 15%. If you cannot afford that, then go for government-insured mortgage loans, they allow a down payment of 3.5% too.

 

Mortgage Rate

You can input the interest rates that various mortgage lenders provide and check how the mortgage payments differ. Keep in mind that your mortgage rate depends on several factors like your credit score and debt-to-income ratio. 

 

Loan Term

You have the option to see how your mortgage payment changes with change in the loan term. The mortgage payment will be at a certain figure for a 30-year loan, something else for a 15-year loan and so on.

 

Deciding how much you can afford

You can find online calculators that give an estimate of how much you can afford. Such calculators take into concern the standard mortgage payment elements, which are the principal and the interest. They also take into account other factors like taxes, insurance, homeowner association dues, etc. which help in determining a real-life monthly payment estimate.

You can also get an estimate of your income and debt like a lender does and give yourself the maximum home loan amount you could afford. To do this, you need to input the following data into the calculator:

  • Your annual income
  • Your mortgage loan term
  • Interest rate
  • Your monthly recurring debt

The calculator will estimate your property taxes and your insurance. You can adjust those values as well. Enter the monthly HOA dues (if applicable). Now, the results will be shown, including the following:

  • An estimate of the maximum mortgage amount
  • An estimate of the monthly mortgage payment
  • The maximum amount a mortgage lender might consider giving you.
  • Your mortgage payment for that amount.

The following tips will help you better decide how much of a mortgage loan you can afford:

  • Most financial advisors say that people should spend at most 28% of their gross income on housing (mortgage payment), and at most 36% of the gross income on their total debt, which includes credit cards, student loans, mortgage payments, medical bills, etc.
  • You need a Debt-to-income ratio of 50% for some loans. Most lenders consider this DTI to be a good figure but you also need to consider other expenses like living expenses, retirement, emergency savings, etc. into your house affordability scenario.
  • Your annual income might be enough to cover your mortgage or it might not be, so you need to consider this factor to determine how much you can afford. This would also help you take financially sound decisions in the next steps. The last thing you would want to do is take up a 30-year home loan because that is a long commitment.

 

Understanding Your Mortgage Payment

The principal repayment amount per month and the interest payment on your mortgage constitute the main components of the monthly mortgage payment. However, monthly mortgage payment also includes other things, like the homeowner’s insurance and taxes that are held in an escrow account.

Monthly Mortgage Payment = Principal + Interest + Escrow Account Payment

Escrow Account = homeowners insurance + property taxes + PMI

What Is Principal and Interest?

The principal is the amount of money you take up as a mortgage loan to buy a house. On the other hand, interest is the extra amount charged by the lender for lending the amount to you. You will be given the yearly interest rate and on dividing this rate by 12 you will get your monthly interest rate.

What Is Homeowners Insurance?

Homeowners insurance is a type of property insurance that covers the losses and damages to an individual’s residence, besides furnishings and other assets you have in the home. It also provides coverage in cases of accidents in the home or on the property. 

While borrowing money to buy a house, the lender will need you to get homeowners insurance. This policy protects the mortgage lender’s collateral (your house) in case of any incident that damages the house.

How Do Property Taxes Work?

Property tax is a type of tax levied on your property, usually on real estate. The amount paid as property tax by the homeowner per year varies based on local tax rates and the assessed value of a property.

Lenders often include property taxes into the homebuyer’s monthly mortgage payments. Private lenders offer a conventional mortgage in which the borrower does not require to pay property tax but FHA loans need you to pay property taxes along with the monthly mortgage payment.

Your lender will deposit your mortgage tax payment into an escrow account. If your property taxes are due to the county then your lender will use this fund to pay the due taxes on your behalf.

What Is PMI?

Private Mortgage Insurance (PMI) is a means of protection for the mortgage in case the homebuyer stops paying, defaults on the mortgage and the home goes into foreclosure. 

While buying a house on mortgage, the borrowers need to pay some amount as a down payment. 20% is considered to be standard by lenders. If the homebuyer is not able to afford that much, then the loan will be deemed as a risky one and require the borrower to pay PMI.

PMI might cost something in the range of 0.3% to 1.5% of the loan amount annually and is included in the monthly mortgage payment. It depends on your credit score and down payment. You can avoid PMI by choosing to buy a less costly home or taking another loan to make the down payment.

What Are HOA Fees?

Homeowners Association fee (HOA fee) is the amount of money that needs to be paid every month by homeowners. HOA is collected by the homeowners association to assist with maintaining and improving the properties under the association. HOA fees affect how much the mortgage lenders are willing to lend you.

How to Lower Your Monthly Mortgage Payment?

 

  • Extend your mortgage repayment term: If you increase the number of years you will be paying the mortgage, then you can expect a smaller bill. For instance, a 15-year mortgage loan will have higher monthly payments than a 30-year mortgage loan. So, you need to extend the loan term.
  • Buy a house that costs less: The higher house purchase price, the higher will be your monthly payments and vice versa.
  • Refinance your mortgage loan: You can consider refinancing your mortgage which might help you choose one with a lower interest rate and smaller monthly payment. You need to have a good credit score to refinance.
  • Find the lowest interest rate: Try shopping around with different lenders to find the lowest possible interest rate. By this your monthly mortgage payments will be kept low.
  • Make a large down payment: If you make a large down payment, then your monthly mortgage payment will be kept low. So, if you pay 20% down, then your mortgage payments will be considerably low and you won’t have to pay PMI as well.
  • Get rid of the PMI: If you save and pay a 20% down payment then you won’t be required to pay a PMI with monthly payment.
  • Redo your home’s tax assessment: Property taxes could take up a huge chunk of money each month. Some homes are overvalued, hence the taxes become high. So, you could request your tax assessment to be done again.
  • Opt for an interest-only mortgage: Such mortgages will require you to pay your interest in the first phase and in the second phase you have to pay off the principal balance + interest. Hence, your payments will be low for the first few years.
  • Pay the PMI upfront: If you didn’t make the 20% down payment, then you have the option of paying your PMI upfront. This way you won’t have to pay extra year after year.
  • Rent out some part of your house: Having a tenant in your home and charging monthly rent from them can help you with your mortgage payments.

 

Mortgage Calculators: Alternative Use

A mortgage calculator will help you with scenarios like how much you can afford, considering a refinance, etc. Some alternative uses of a mortgage calculator are as follows:

  1. Pay off a mortgage early: When you take up a 30-year mortgage loan, then by the end of 30 years, you would have made much larger interest payments than the original principal of the loan. Many calculators have an “Extra Payments” function, this will help you find out how to shorten your loan term and pay off the loan early by paying extra money. You will be able to see the “Amortization Table” and assess how much interest you will end up paying and your new payoff date if you shorten the term.
  2. Decide if an ARM is a good option or not: Enter an ARM interest rate into the mortgage calculator and compare the payments to the fixed-rate mortgage payments. This way you will be able to know how much you will save initially if you go for an ARM and decide if it is worth the risk.
  3. Find out when you won’t be levied with PMI anymore: When your home reaches 20% equity that is when you can request your lender to waive the PMI requirement. A mortgage calculator can help you with this.

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