Getting your first mortgage can be an exciting but daunting prospect. Whilst many people think of their mortgage costs as the monthly payment on their property, there are also a number of other expenses, such as your down payment and closing costs, which need to be taken into account. Here we'll explain the additional costs of taking out a home loan which you may not be aware of, helping you prepare financially for this important undertaking.
Mortgage Costs Explained
Your initial cost when taking out a mortgage is the down payment. This is typically 20% of the total cost of your property, and acts as a deposit. Depending on your mortgage, this may or may not be refundable if the deal falls through, and it is useful to note that not all down payments are 20%, especially with FHA loans.
Regardless of the type of mortgage you decide upon (fixed rate or variable rate) your monthly payment is actually made up of a series of underlying costs for the property.
In most mortgages these costs can be simply split into two categories, principal and interest. Principal refers to the amount of money originally borrowed, and interest is the fee charged on top of that for borrowing the amount. Although your monthly cost may not change (depending on your type of mortgage), the percentage of your monthly costs going to principal and interest will.
For example, take $1,000 as your monthly payment amount. Initially, most of this will go to interest, say $900 on interest and $100 on principal costs. As time goes on and more of the principal cost is paid, the interest costs will also reduce and monthly mortgage premiums will be going mostly towards principal costs; i.e. $900 principal and $100 interest.
Typical mortgages comprise of principal and interest costs, as mentioned above, but also real estate taxes and insurance. If your mortgage does not take these into account then you must pay them yourself and the following information is particularly useful.
Annual property tax is calculated by taking the amount of taxes assessed on a property and dividing this by the number of monthly payments in a year (usually 12). The property tax amount is then paid every month to the lender and this money is held in escrow until the taxes are due.
Property insurance protects the home and its contents against fire, theft and other damages. All properties require this, but for those who have funded 80% or more of their property's purchase price through a mortgage, part of their insurance will also cover PMI – private mortgage insurance. PMI protects the lender in case the borrower defaults, i.e, cannot pay back the mortgage.
After years of making monthly payments, when the end of paying off your mortgage is in sight, don't forget about closing costs.
These include a range of expenses, which can be divided into two categories: recurring and non-recurring. Recurring costs include homeowner's insurance and property tax, and one year's worth of each must be paid to the lender in advance of the mortgage ending for the lender to put in escrow; ready for when it is needed. Non-recurring costs include fees often related to real estate transactions such as credit report costs and title search fees.
Whilst some mortgages may take closing costs into account, many do not - as these can often average more than 5% of the original loan, meaning that if this is taken into account, monthly payments are much higher.