Mortgages

The content contained on or made available through this website is not intended to and does not constitute as legal or investment advice. Please use and refer to the information at your own risk, and consult with a professional before making any finance-related decisions. Refer to the full Terms & Conditions here. Last updated January 1st, 2020.

Takeaways

  1. Understand the components of a mortgage

  2. Factor in additional costs to a house’s asking/selling price

  3. Determine expected monthly mortgage payments

  4. Ensure the house and payment structure are suited to your current and future needs

  5. Only buy a house if you plan to live there for at least 5-10 years

 

A mortgage is a loan backed by a property - typically your house. If you are unable to make consistent payments (called defaulting), the mortgage facilitator (usually a bank) may evict the residents and sell the home to cover the remainder of the debt. Having a large physical asset as collateral allows banks to provide loans in the hundreds of thousands to the average borrower.

 

Below is a list of the key factors that make up a mortgage:

 

House Selling Price

 

  • The value of a home depends on a host of variables. These include: location, size, county or district, availability of schools, tax rates, etc. The best way to get an idea for house prices in a certain neighborhood is to visit a website such as zillow.com to see historical and current selling prices.

 

Taxes and Fees

 

  • Annual Expenses: Taxes and fees that are included in the cost of owning a home. These are typically lumped into the mortgage payment, and include:

    • Property Tax: Taxes owed to the governing body of the jurisdiction in which the property is located (e.g. state, county, or municipality). Property tax depends heavily upon the location/size/value of the house and school district, and is typically 1% - 3% of the house’s selling price. This can add up to 25% - 50% of your monthly mortgage payment, and must be paid in perpetuity. Property taxes should be among your top considerations when house-hunting.

    • Property Insurance: Homeowners insurance policies typically cover forces of nature (such as fire, wind, and hail), while also providing liability coverage in the case that someone other than the owner becomes injured on the property. Because the mortgage provider uses the house’s value as collateral, most lenders require you to have this coverage. The cost of property insurance ranges based on the house’s value, but in most cases is between 0.25% and 0.75% of the selling price.

    • Homeowners Association (HOA) Dues: Fees that are levied on certain types of housing (most often condominiums, but sometimes neighborhoods and single-family homes as well) that are used to maintain the property, upkeep common living spaces, and more. HOA dues vary dramatically from property to property, and largely depend upon the services provided. Overall they typically range between $100 and $500 per month.

 

  • Closing Costs: One-time expenses that are incurred when you purchase a home. Together, these expenses typically add up to 3% - 6% of the mortgage principal, and include:

    • Application Fee: The charge made by your lender in order to process your application. What this includes and whether or not you will have to pay the full amount is typically negotiable.

    • Home Inspection & Appraisal: Fees for determining the fair market value of the house and subsequently verifying its condition (e.g. future need for repairs).

    • Title Search Fees: Fee charged by the title company to cover the cost of ensuring that no one else has a claim to the property.

    • Other Examples: Attorney fee, credit report fee, underwriting fee, escrow deposit fee, courier fee, pest inspection, etc.

When looking at houses, a good exercise can be to compare the cost of rent to the combined cost of property tax/insurance, HOA dues, and closing costs. These expenses do not contribute to Principal or Interest, and are therefore sunk costs (similar to the sunk cost nature of rent). So, if these costs exceed that of rent, then that could be a sign to look elsewhere.

Private Mortgage Insurance (PMI)

 

  • If your down payment is less than 20% of the selling price, you will incur an additional monthly fee called PMI. Typically 0.5% - 1% of the mortgage, PMI partially insures the bank against you defaulting on payments (as you are assumed to be a higher risk borrower). Due to the additional cost of PMI, it is often best to make a 20% or greater down payment.

 

Annual Percentage Rate (APR)

 

  • The APR is your interest rate. The lower the rate, the lower your mortgage payments. APR depends heavily on the current interest rate environment as well as your credit score. The higher the credit score, the lower the APR. Mortgage APRs come in two forms:

    • Fixed Rate: The standard option, a fixed rate mortgage uses a single APR over the course of the loan. Payments are level month-to-month. If interest rates increase in the future, you will be unaffected. If they decrease, you have the option to refinance your loan and potentially benefit from lower interest payments.

    • Variable Rate: Variable rate mortgages charge monthly payments that vary alongside economic interest rate conditions. They will often offer a low “teaser” interest rate to get people interested. However, borrowers are on the hook for sudden increases to interest rates (and therefore higher monthly payments). While there is some upside, these are risky and often not recommended.

 

Summary

Monthly Mortgage Payment = Principal Payment + Interest Expense + Annual Expenses + Closing Costs (one time) + PMI (if applicable)

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Conclusion

More goes into buying a house than just the selling price. Annual expenses and closing costs can add up to an additional 5% - 10% of the house’s value to the mortgage. Furthermore, you will be responsible for utilities and maintenance expenses, both of which vary widely from house to house. Understand the options, take your time, and consider buying only if you plan to live there for at least 5-10 years. Doing so will make the closing costs a worthwhile expense.

The content contained on or made available through this website is not intended to and does not constitute as legal or investment advice. Please use and refer to the information at your own risk, and consult with a professional before making any finance-related decisions.

© 2020 London Levinson LLC