In the ever-changing world of real estate it can be confusing for new home buyers to determine what their price range is for their first home purchase. A lot of different factors play into your monthly payments on a mortgage: usually Principal, Interest, Taxes, and Insurance (PITI).
However, the common misconception is that when you go through the loan approval process you will be qualified for a Sale Price (ex. $150,000), when in reality you are approved for a monthly payment maximum (ex. $1,200/month). It’s important to know what makes up that payment amount when you get an estimate from your loan officer, because it affects how high you can go in Sale Price. And if one or more of those factors change, that can reduce the amount of house you can afford.
Principal
This is the actual amount of money you are borrowing. So if you are purchasing a home at $200,000 and you are putting $20,000 down, then you principal amount on the entire loan would begin at $180,000. Simply stated: the more of your own money you put up as a down payment, the lower your principal will be on the loan payment.
Interest
This is a key factor in your monthly payment, since at the begin of your loan amortization you will be paying mostly interest, and very little principal. Over time, this evens out, but a higher interest rate actually means your purchase price decreases. That’s why these historically low interest rates are AWESOME right now, because it means first time home buyers can afford more house for the same monthly payment as they would have been paying with higher interest rates and lower priced homes.
Taxes
Taxes are out of anyone’s individual control, so make sure you factor this into your estimates. The county tax records should be checked prior to making an offer in ensure that you will be able to afford those monthly escrow payments.
Insurance
This is for both home-owner’s insurance and mortgage insurance (unless you’re putting at least 20% down). Many buyers don’t realize that they will pay a full year’s worth of home-owner’s insurance up front when they buy, and then make monthly payments into their escrow account for the next year’s hazard insurance. Also, mortgage insurance can be a big factor especially since your loan program will determine how much mortgage insurance you’re required to pay every month. After a certain time frame (usually 5-8 years) this goes away, but you want to make sure you’re accounting for these costs when figuring your monthly payments.
I highly recommend talking with your loan officer and making sure you understand all the estimates they are calculating in your pre-approval. Some lenders will estimate low on taxes, insurance, or even give you a quote for interest rates that are lower than what you would actually qualify for. Our friends at Cornerstone Mortgage always fully disclose everything, and more importantly they make sure you can compare different estimates easily to theirs to make sure you’re getting the best deal possible.
