How much will a mortgage cost?

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Mortgages

I. Does the mortgage fit your budget
II. What is a Mortgage?
III. How much will it cost?
IV. Pre-Qualification to Closing

How much will it cost?

The size of your monthly mortgage payments will mainly be decided by the principal amount you owe plus interest payments. For the most part, the cost of the home will determine what the principal amount owed will be. Credit score, points, will help set the interest charges. The size of the down payment can affect both the size of the principal and the rate of interest.

Down Payment

Many lenders require a down payment in order to qualify for a mortgage. This can be problem for many borrowers since the required down payment may be a large amount of money. For example, a lender might require at least a 5% down payment on a home with $200,000 sale price, which would be $10,000. Typically, lenders are looking for a larger down payment than the one used in the example above. A down payment representing 20% of the homes sale price is preferred, but, fortunately, not usually a requirement (FHA loans require a down payment of around 3%, in some cases less). You still may qualify for a mortgage even if a 20% down payment is out of the question. But you will probably have to pay private mortgage insurance (PMI) if you can only afford a down payment of less than 20%. This insurance policy from a mortgage insurance company, which is usually picked by the lender, protects the mortgage lender in the event that the borrower cannot pay back the mortgage loan. This is great for the lender, not so great for the borrower since monthy insurance premiums come with the deal.

How much will the monthy insurance premiums cost? In the previous example, a 5% down payment of $10,000 was made on a house with a $200,000 sale price, leaving $190,000 (95%) of the principal left. A good rule of thumb for estimating the cost of private mortgage insurance is one-half of 1% or .5%. Multiply $190,000 by .5% and you come to $950 a year or $79.17 per month. You would have to continue to make these insurance payments until about 1/5 of the principal has been repayed. There are some lenders that allow borrowers at closing to pay the total insurance premium with a lump sum payment.

There are, thankfully, other options for those who cannot afford a 20% down payment that does not include mortgage insurance premiums. Government backed mortgages from the Federal Housing Administration (FHA), which is part of the Department of Housing and Urban Development (HUD), and the Department of Veterans Affairs (VA) are two of them. (Note: "FHA does not actually make the loans. Instead, it insures loans so that if borrowers default, the lenders will get what they are owed.)

Also, agreeing to pay a higher rate of interest instead of insurance premiums may be an alternative offered by a lender. On a first or second home interest is tax deductible, making higher interest rates preferable in this case. In addition, the increase in interest, if offered, probably will only be .75% or 1%, depending upon the down payment requirement.

There is also the zero down payment, also called 100% financing, option -- available as a first mortgage only or a first and second mortgage combined, also know as a "piggyback" mortgage.

Requirements for 100% financing:

Credit rating of at least 620

Typically, requires the use of both a first mortgage and a second mortgage

Debt to income ratio of 45 or less

Property must be occupied by owner

Interest Rate

The rate of interest you pay on a mortgage can be affected by several factors. The size of your down payment, as mentioned earlier, your credit rating, and the number of points you pay.

An individual with a poor credit rating -- typically, under 620 -- is considered to be a high risk borrower. To offset this risk, a lender might offer a mortgage with relatively high interest rates. Or, if you are dealing with a prime mortgage lender, reject your offer and perhaps recommend that you apply for a subprime mortgage.

Points

You may of heard points mentioned in mortgage advertisements in the past and were unsure of what they were exactly. One point is equal to 1% of the principal. Points are considered fees that are payed before a mortgage is closed. Up to five points, in some cases, can be part of what a lender charges. Whether or not you agree to pay points should depend upon what type are offered.

Typically, discount and origination points are the two types of point charges a borrower can receive. Discount points reduce the amount you will pay in interest by lowering the principal 1% with each point payed. Lowering the principal in this manner is an attractive offer for those who can afford to. Discount points, by the way, are tax deductible.

Origination points, on the other hand, are not tax deductible. These points really just cover the cost of processing the loan. From the point of view of the borrower, origination points are far more expensive.

Mortgage Fees

This is when the real comparison shopping begins. When you apply, the lender(s) will supply you with what is called a good faith estimate of closing costs, among other documents. This document is usually called a good faith estimate (GFE). According to the federal Real Estate Settlement Procedures Act (RESPA), it must be sent by the lender, to the applicant, within three days of applying. An estimate of all settlement costs (also called closing costs), fees payed before closing, and any escrow costs are listed on the GFE document. Comparing the good faith estimates from several lenders is a great way to find the best offer.

On a good faith estimate what you see may include:

A fee to have your property appraised, which typically runs between $300 and $500

A home inspection fee, which typically ranges between $250 and $500

Interest you may have payed from closing date to 30 days before first mortgage payment

Recording fees

A receipt for homeowner's insurance policy indicating that it was payed and, if necessary, fire and flood insurance

Fees for documentation preparation

A fee for obtaining a credit report

A loan application fee, which covers the cost of the lender processing your application

A loan origination fee for processing your loan. This fee may be expressed in the form of points or a dollar amount and is typically 1% of the loan amount

Discount points that lower your interest rate. In some cases, also origination points.

A fee for a search of the public records regarding the ownership of the property

A title insurance policy, which protects the lender for any loss due to inaccuracies in the title

A fee to cover the cost of conducting a new survey of your property

Attorney, notary, and mortgage broker fees

A fee to cover tax related services

In addition to the good faith estimate, the Truth in Lending Act statement (TILA), a Servicing disclosure statement, and the Affiliated business arrangement disclosure must also be sent by the lender, to the applicant, within three days of applying.

Next: Pre-Qualification to Closing

Updated: Nov 2005