Figuring out what your mortgage and property expenses will be is very important to know whether or not you can afford a home. There are a few secondary expenses outside of a conventional mortgage that many people are not aware of. In this post, I'll explain the costs associated with a mortgage and some additional expenses that will factor in to the average homeowner's monthly expenses.
The magic acronym here is PITI. These are the four major components that affect a homeowner's monthly expenses. Fortunately, Chad Pluid recently wrote a short article entitled, "How to Calculate Your Monthly House Payment" for Redfin that defines these costs. They have also included a short video to explain the costs and what they're for.
- P is for Principal
The principal is the amount of money that you borrow. It's pretty straight forward. If you buy a house for $200,000 and get a mortgage for the full amount, your principal amount is $200,000.00. If you put 10% down and borrow the rest on the same amount, your down payment will be $20,000.00, which is deducted from your principal and makes your principal amount $180,000.00. Essentially your principal is just whatever amount you need to borrow from your lender.
- I is for Interest
The amount of interest that you will owe on your mortgage depends entirely upon your individual situation. You could have outstanding qualifications according to your lender and that would reduce your interest amount. If you have other loans (higher debt to income) or less than stellar finances, it is likely that your interest rate will be higher. You have to remember that your lending institution is basically investing in you when they lend you money. They are giving your the privilege of borrowing their money and they expect a reward for doing so. Interest is what they get paid back for lending your their money. If you can prove to be a safe investment (by your history of being financially responsible), they will feel more confident in the investment and give you a more favorable interest rate. There are two standard loan lengths for mortgages. 30 years and 15 years. Depending on what you choose, the loan will be amortized to be paid off within that many years. 30 year mortgages are more common. 15 year mortgages usually have a lower interest rate, but they require higher monthly payments because they are a shorter duration loan. At the moment, the average 30-year fixed mortgage interest rate is 4.15% according to Bank Rate. That's pretty damn low compared to a few years ago. Usually, your payments near the beginning of the mortgage will be interest-only because of the higher principal. Eventually, you will begin to pay down your principal amount.
- T is for Taxes
Taxes vary from state to state and from property to property. You can look up your state's tax rates and figure that out with some basic math. There are usually different tax rates on properties depending on it's usage and residency. If you are an owner occupant, your tax rate will be lower. If it is a commercial property (rental), your tax rate will be slightly higher. In South Carolina, our owner-occupied tax rate is 4% of the value of the property. There is an additional amount added to your state tax by your counties tax rate. It is usually much lower. The amount of county taxes is determined as a "millage rate." You'll notice that I hyperlinked term to an outside source. It's complicated to explain the millage rate. It's basically your estimated contribution needed by your local government in order to cover their budget for the year. It breaks down to 1/1000th of your property taxes. If you're interested, just look it up. This figure changes often.
- I is for Insurance
Insurance is the hardest of these costs to estimate. Insurance policies and premium are based upon risk assessments. If your property seems riskier to your insurer, they will charge you more. Insurance premiums will depend upon things like the value, age, construction (materials and practices), landscaping (large trees), area, natural characteristics (lake, river, etc.), type of home, so on and so on. The more factors that could lead you to need to make a claim, the more the policy is going to cost you. This cost is also affected by the consumer's choice of coverage. If you want a lot of coverage against different dangers, they will charge you more. If you happen to be more conservative and want a policy with a higher claim in case of disaster, you will have a higher monthly payment. Insurance companies treat their policies similarly to how banks treat interest rates. If they think that there is little chance of paying out a claim at your property, you will pay less in premiums. If they feel that your property is higher risk, meaning that they are likely to have to pay out claims, they will charge you more. Furthermore, there are some geographical areas that require additional coverages that will cost you more. There are some places where it is Government-mandated to have secondary policies that will insure against things like earthquakes or floods. In the Charleston area, it is very common for a homeowner to be required to carry flood insurance. Depending on the flood zone, some of these flood insurance policies are outrageously high. Again, this is a risk assessment from the company that binds the coverage. I have heard of policies in the Charleston area ranging from $200.00 to a whopping $30,000.00+. No kidding. The easiest way to find out if flood insurance is required is to ask your Realtor to check the tax map and see what flood zone your prospective home is in. Depending on your area, you might not need it. If you do need it, you can either get a new policy or you can assume the previous owner's policy and make your monthly payments to your provider. I personally live in an X zone and do not need flood insurance.
There you have it. Those are the factors that determine your monthly house payment. The most important thing is to make sure to employ the aide of professionals when shopping for your new home. Make sure to use expert Realtors, lenders, insurance providers. They can make all the difference in the world.
As always, if you or anyone you know needs help buying or selling a home, please let me know. If you have any further questions about real estate, feel free to reach out to me.
Troy Franklin Gandee