*Note, for the sake of simplicity, I will just be talking about a 30 year fixed rate mortgage in this article*
We all know what a mortgage is, but how does it work? What is PMI?
For those of us who have never owned a home, but are interested, I thought I would take the time to break down how a mortgage works. I would also like to go over some factors that influence it and things that may happen to a mortgage over it’s lifetime, and PMI.
The concept of a mortgage is pretty simple. Paying back the money that you borrowed to purchase a home. You, or CHFA or someone else, put down 3.5%, the lender put down 96.5%, and now you have to pay them monthly to get out of that debt.
But how does it work?
Well, it’s not quite as simple as just paying the loan back. I mean the bank has to get their cut, right? If you just paid them the loan back, they would have just given you money to pay back over 30 years.
That makes no sense. Actually, you will end up paying pretty close to the amount of the loan in interest over the life of the loan. What does that mean? Well, the bank’s cut will probably be pretty close to how much you borrowed.
But How does it ACTUALLY work?
You and the bank will pick out a monthly payment, based on your debt to income. From there, they will determine your loan amount. The Interest rates will be applied based on your credit score and pre approval.
Let’s say your interest rate was 4.625% and your loan was $350,000. You were able to put down 3.5%. And for simplicity’s sake, your monthly payment was $1,450.
It’s not as easy as just paying half interest and half principal (the loan). No, it’s actually much more complicated.
The way a mortgage payment is split up is calculated like this: First dividing your interest rate by 12 (to get that month’s interest payment). Then multiplying that number by the current amount left on the loan. What is there is your current interest payment, the rest goes to the principal.
I know, that doesn’t make much sense. But let me write it out by showing you what your first mortgage payment would go to on that loan.
- Find the interest payment
- 4.625%/12 = .355%
- .00355 * 350,000 = $1,243.96
So your monthly payment is $1,450 and your first interest payment is $1,243.96. That means that only $206.04 would actually go towards paying down your loan for that first month. But that’s how mortgages are set up, when you are done paying what you borrowed, the bank has made their interest back already.
But that’s not all that goes into a monthly payment!
PMI Stands for Private Mortgage Insurance. It is an additional charge put onto a monthly mortgage payment until the first 20% of the loan is eliminated, either by equity or payments.
PMI is calculated by the amount of money you put down on the loan, but it usually ends up being about $100 – $350, added onto your monthly payment.
Taxes are also added onto your monthly payment, but it’s a little bit different. See, your taxes are due once a year. But instead of leaving this up to you, your lender creates an escrow account (an account created just to hold someone else’s money) and takes money from you throughout the year to pay for this. This helps soften the blow a bit. Taxes range a lot, and are really hard to estimate, but are generally right around the cost of your PMI.
You will also have a homeowners insurance charge to pay.
So if you are talking to a lender, and they only tell you your monthly payment for Principal and interest, remember there will be more for you to pay. Well, you now know it’s going to be PMI, Taxes and Insurance.
The good news is that these three additional charges are tax deductible.
Yeah, that’s pretty big, and it definitely beats out paying rent!
Thanks for reading!