For most people, a mortgage is the largest loan they’ll ever have. It's essential to understand all that goes into the cost and your responsibility in paying it back.
Instead of focusing solely on your monthly payment, take a step back and look at the total expense spread across the entire term of the loan—for many people, that’s 30 years. The average home price in the U.S is around $415,000. If you make a 5% down payment and have a 5% interest rate, you’ll repay a total of $761,910—that’s $367,600 in interest, alone.
But if you change the interest rate, you change the repayment total. For instance, if your interest rate for the loan is 7% instead of 5%, the interest repaid jumps to $550,013, with a total cost of $944,263.
Multiple factors can change the overall cost of a mortgage, but the interest rate and term length usually have the largest impact.
A mortgage is repaid in monthly installments through a process called amortization. This takes a large amount and makes it more affordable by splitting the interest and principal into scheduled payments that stay the same. In the first few years of a mortgage, most of your payment goes towards interest and only a small amount goes to paying down the principal. Near the end of the term, the opposite is true—most of the money goes towards the principal and very little toward interest.
Because a mortgage is such a huge cost, it’s worth exploring ways to reduce your costs.
There are two types of points associated with a mortgage loan: discount points and origination points.
Your monthly mortgage payments include a few other costs unrelated to the loan principal and interest. If you paid less than 20% down, you’ll owe PMI, which is usually 2-5% of the overall loan amount. You’re required to pay PMI until your principal balance is 78% or less of the original value of your home.
Your payment will also include your real estate taxes. The exact amount varies depending on the state and county you live in; but plan on at least a few hundred dollars a month. Real estate taxes are based on the assessed value of your property (not necessarily what you would sell it for today) and the tax rate for your municipality. These taxes pay for public schools, police and fire, highway maintenance, and other government services.
Homeowners insurance is another cost you may pay monthly or annually. This is required by your mortgage lender, and you’ll need to provide proof of current insurance if you pay that separately.
Your community may also have homeowner’s association (HOA) fees that you are responsible for. These are not part of your monthly mortgage payment, but they can be costly. So make sure you know what the fees are and how often they are due. Failure to pay HOA dues can result in a lien against your home.
To manage the high annual cost of property taxes and homeowners insurance, your mortgage lender will set up an escrow account for you. An escrow account is a savings account managed by your lender for the sole purpose of paying these important bills.
You’ll make required escrow payments as part of your monthly mortgage payment, and those are deposited into your escrow account. When an escrow item is due—such as your annual property taxes—the lender is responsible for paying the bill on time, not you.
Many lenders require escrow accounts under the terms of your mortgage, to make sure you don’t fall behind on these obligations. Some lenders allow you to remove or cancel your escrow account after a period of time, but then you’re on your own to plan for and pay these annual bills.
Your bottom-line mortgage payment includes principal, interest, and escrow, which is property taxes and insurance.
Be sure to consider all the costs associated with a mortgage for a complete picture of what it really costs.
This article has been republished with permission. View the original article: The Cost of a Mortgage