Your Monthly Mortgage Payment: An Important Decision

In an earlier article, we walked through the six most important home-buying decisions. One of them is figuring out a monthly mortgage payment that’s right for you. That, along with your down payment, will determine how much home you can afford.

What’s Included in a Monthly Mortgage Payment?

Before we talk through the ways you can determine a dollar amount that’s right for you, let’s go over the pieces that make up your monthly mortgage payment. You need to consider each of these:

1. Principal: If you buy a home for $300,000 and make a 20 percent down payment ($60,000), you’ll need to borrow $240,000 ($300,000 home price – $60,000 down payment) to make up the difference. Therefore, you’ll be paying back a piece of that $240,000, the loan principal amount, every month for the loan term. Unless you have an interest-only loan, your monthly payment will include a principal payment.
2. Interest: This is the primary cost of borrowing money. Interest is commonly referred to as a percentage, or the note rate, and expressed as an annual rate. For instance, if your loan amount is $240,000 and your note rate is 5 percent, you’ll pay $1,000 in interest for the month ($240,000 loan amount X 5 percent annual note rate ÷ 12 months in a year).
3. Property taxes: Property tax amounts can vary widely depending on where you live. For example, if your home is worth $300,000 and you have a 1 percent annual property tax rate, your monthly property tax payment would be $250 ($300,000 home value X 1 percent annual tax rate ÷ 12 months in a year).
4. Hazard insurance: If you buy a home with a mortgage, hazard insurance is required. This protects you and the bank against damage to your home. It is typically an annual dollar amount (called an insurance premium) and can vary depending on the replacement cost of your home, along with factors that may increase or decrease the risk of events such as fires. Say your annual premium is $1,200. As a result, your monthly hazard insurance payment would be $100 ($1,200 ÷ 12 months in a year).
5. Mortgage insurance: This is a monthly amount that you’ll likely have to pay if you make less than a 20 percent down payment. Mortgage insurance offsets some of the risk banks experience with lower-down-payment mortgages.
6. Homeowners association dues: Some homes are in areas that have HOA dues. These might pay for a community pool, community landscaping, or common building costs of a condominium.

Monthly Payment Calculator: The Fast Way

If you want to quickly estimate how much you can afford every month for your mortgage payment, multiply your annual income (before taxes and deductions) by 2 percent.

If you make $60,000, this fast method gives you a total mortgage payment of $1,200 ($60,000 X 2 percent). This is only meant to give a general idea. Banks will take a hard look at your income and your other loan payments.

Monthly Payment Calculator: The Bank’s Way

Banks care about your debt-to-income ratio (DTI). This gets a little trickier. A good place to start is a 30 percent DTI. This gives you a little wiggle room if you find a home that is a little more expensive or if the bank doesn’t count all your income. While most banks will allow up to a 36 percent DTI, some go as high as 43 percent.

Let’s stay with our example of $60,000. Your monthly income in this example is $5,000 ($60,000 annual pre-tax income ÷ 12 months in a year). That $5,000 is the “I” part, income, of DTI. Since we’re targeting a 30 percent DTI, your total debt payments can be $1,500 ($5,000 X 30 percent). The “D” part, debt, of DTI includes all your loan payments. Let’s say you have a $200 monthly student loan payment and a $400 car loan payment. Thus, your mortgage payment would be $900 ($1,500 debt payment target – $200 student loan payment – $400 car loan payment).

Monthly Payment Calculator: The Budget Way

At Bundle, we strongly suggest you complete a monthly budget, and we have a great tool that can help. This only takes 10 to 15 minutes and is well worth your time, considering that a home is the largest investment most people are ever likely to make.

In the DTI example, you may have thought to yourself, “Wait a second! I have a lot more expenses than just a student loan payment and car payment. What about groceries, gas, and clothes?” That’s exactly the reason we strongly suggest that you complete a budget, regardless of the tool you use (though ours is pretty awesome). Here’s the example given in our article “The Six Most Important Home-Buying Decisions”: