A mortgage is a loan used for buying a house, paid back in monthly installments over many years. This is call a mortgage payment. Most people find it easier to spend a few hundred or a few thousand dollars a month to pay for their house than to buy the thing with one enormous stack of bills, and lenders such as banks are happy to lend the money, because they make quite a bit back on interest without having to do much. For an introduction to mortgages, check out Mortgage 101.
Ask our friendly team about the loan that’s right for you
Since a mortgage exists primarily to make home ownership affordable for most people, quite a few considerations go in to structuring the ideal loan for each borrower. Some people want a loan they can pay off as quickly as possible. Others are going for the lowest monthly payment, regardless of how long it takes to pay off. Some people want to put as little money down as possible, while others are willing to pay more up front to save money in the long term.
Three main mortgage cost considerations
But loan amounts don’t just affect your payment amount, but also your likelihood of getting financed in the first place. Learn about qualifying for a mortgage. If your mortgage payment is going to gobble up a substantial portion of your monthly income, the bank will be hesitant to lend you the money, fearing that you might be forced to miss payments–or default altogether–due to unforeseen events or simply a lack of discipline. Conservative opinions recommend that your mortgage shouldn’t be greater than 2.5 times your annual income, while the more profligate experts would tell you that 4-5 times your salary might be starting to push it. It’s a wide range, and where you fall depends on both your real cost of living (lifestyle) and your tolerance for financial strain.
Your interest rate, or basically the extra money you’re going to pay back to the bank for the privilege of borrowing, is a huge factor in determining your monthly payment. A 30-year loan for $200,000 is going to run you $955 per month at a 4% interest rate. At 5%, only one percent higher, your payment will be $1,074. The difference over the full term of the loan will amount to almost $43,000, so low interest rates are extremely attractive to borrowers.
Interest rates depend primarily on a variety of complex factors, including the general state of the economy, and fluctuate wildly over decades. Rates in recent years have been extremely low, getting well beneath 3.5%. This is a stark difference from the early 1980’s, when rates were in excess of 15% over several years. That $200,000 loan from the prior example would have run the borrower $2,529 per month, or close to triple the cost! Basically, now is a great time to get a loan. Ask us for rates!
The other determining factor when it comes to your interest rate is how risky a borrower the bank thinks you’ll be. If you seem like you might miss a few payments based on your income, the nature of your job, or your past history, they might still lend you the money, but will want to charge you a higher interest rate for doing so. They might add as much as a few extra percentage points, which will increase your payment, and their profitability, which many would see as fair compensation for taking on greater risk.
The longer you have to pay off your mortgage, the lower your monthly payment will be. This is why many people opt for a 30-year loan; it enables them to buy a more expensive house and keep their payment within their budget. For instance, our earlier example of a $200,000 loan (at 4%) that costs $955 per month over 30-years is $1,479 per month on a 15-year term.
But because the 30-year term takes longer to pay off, the borrower pays more than double the total interest by the time they’ve satisfied the debt ($143,739 rather than $66,288). And for only 1.5 times the monthly payment, they can pay off the 15-year loan twice as fast, and then they’ll have no mortgage payment, so many people see it as a better deal.
|Total Interest Paid||$143,739||$66,288|
Another advantage to a shorter loan term is that most banks will reduce your interest rate significantly, since they’re getting paid back faster. On January 29, 2015, 30-year loans were going for 3.66%, while 15-year loans were at 2.98%. So the difference in monthly payment is much less, and the total interest savings over the term of the loan is far greater.
|Total Interest Paid||$129,777||$48,263|
The way you like it
If you want a house but, like most people, don’t have the cash to buy it free and clear, you’re going to have a mortgage payment. But if you have reasonably good credit and the house you’re buying isn’t haunted or otherwise difficult to resell, you can have your mortgage professional structure your loan in a way that makes the most sense to you. If a low monthly payment is paramount, go for a longer loan term. If it’s a low interest rate you’re after, and net savings over the life of the loan, opt for a shorter term. And by putting down a bigger down payment, you can reduce the total loan amount, and show the bank that you’re a low-risk borrower, and you’ll likely see a significant reduction in both your rate and your payment.