By borrowing money, you can leverage your real estate investments to afford a more expensive property. Understanding how to calculate a mortgage payment is crucial for making informed decisions when expanding your real estate portfolio.
Typical Costs Included in Your Mortgage Payment
Your mortgage payment comprises several costs beyond the amount you borrow to purchase a home. Some of these expenses are within your control, while others are fixed monthly charges that must be included, such as interest, taxes, and insurance.
Principal
The principal is the amount you borrow to buy a home. To calculate it, you need to determine your down payment on the property.
For example, if you’re looking at a property priced at $300,000 with a $100,000 down payment, your loan principal would be $200,000—the amount you need from the bank to finalize the purchase.
Interest
Interest is the cost of borrowing money. You pay an annual interest rate, but your mortgage payments are calculated with a monthly rate (the annual rate divided by 12). Interest rates for investment properties tend to be slightly higher than for primary residences due to the increased risk of default.
Initially, your mortgage payments will consist more of interest than principal. However, as you gradually pay down the principal, the interest portion of each payment will decrease. To save on interest, it’s beneficial to shop around for the best loan terms.
Taxes
Property taxes are an essential component of your mortgage payment, as they are mandatory for owning a home. As the homeowner, you are responsible for paying these taxes. You can either set up an escrow account to include one-twelfth of the annual tax bill in your monthly mortgage payment or pay the property taxes directly. Regardless, you should factor property taxes into your mortgage payments to ensure you stay on top of this expense.
Mortgage Insurance
Conventional loan lenders require private mortgage insurance (PMI) when borrowers put down less than 20% on a property. This insurance protects the lender in case the borrower fails to make the required payments, providing extra assurance when lending to an investor with a loan amount greater than 80% of the property’s value. To avoid mortgage insurance, you need to make a down payment of at least 20%, which is a common requirement for most investment loan programs.
Homeowners Insurance
Lenders require property owners to have homeowners insurance to protect against potential losses to the home. Most lenders mandate coverage that equals 100% of the home’s replacement cost to ensure sufficient financial protection to rebuild the property in the event of a total loss, such as from a fire.
HOA (Homeowners Association) Fees
If the property is part of a homeowners association (HOA), you’ll be responsible for paying the associated fees. While most lenders do not include HOA fees in your mortgage payment, these fees are still part of your overall monthly expenses. It’s important to factor them in when calculating your total monthly costs to determine if a property is financially viable.
What Is Amortization, and How Does It Affect Your Payment?
Mortgage amortization refers to the process of repaying a mortgage loan over time. Mortgages typically have a fixed monthly payment and a set end date. Although your monthly payment remains the same, the portion allocated to the principal and interest changes each month, even if the interest rate itself does not.
For example, if you borrow $200,000 over 30 years at a 6% interest rate, your monthly payment would be $1,199.10. In the first month, $199.10 would go toward the principal, and $1,000 would cover the interest. By the 12th month, you would pay $210.33 toward the principal and $988.77 toward interest.
By the final payment, $1,193.44 would go toward the principal, with just $5.97 going to interest. As this example shows, the interest portion of your mortgage payment decreases over time while the amount applied to the principal increases.
How to Calculate Your Monthly Mortgage Payment?
Knowing how to calculate your mortgage payment is important, but if you prefer that the calculations are done for you, there is an easy mortgage calculator.
An easy formula
To calculate your monthly mortgage payments, you’ll need the following information:
- (M) Monthly payment amount
- (P) Principal amount or the loan balance
- (I) Annual interest rate divided by 12 months
- (N) Number of payments
The mortgage formula is calculated as follows:
M = P [ I (1 + I) ^ N] / [ (1 + I) ^ N ? 1]
As you can see, using a mortgage calculator provides the easiest way to calculate your monthly payments, especially as you look at different financing options when buying an investment property. The key is finding financing you can afford that makes sense in your operational costs.
What Are the Different Types of Mortgages?
As a property investor, you have several loan options to consider. While government-issued mortgages are generally not available to investors, except in rare cases, other types of loans can suit your needs.
Conventional Mortgage Loan
A conventional mortgage loan is not backed by the government and comes in two main types: conforming and nonconforming loans.
Conforming Loans: These loans adhere to the Federal Housing Finance Agency (FHFA) guidelines, which include limits on loan size, credit score, and debt-to-income ratios. The current conforming loan limits are $726,200, and in high-cost areas, they can go up to $1,089,300.
Nonconforming Loans: These loans do not follow FHFA guidelines and offer more flexible options for investors with unique credit situations or who are purchasing high-value properties.
Fixed-Rate Mortgage
A fixed-rate mortgage offers a stable interest rate for the life of the loan, making it straightforward to calculate monthly payments. Your monthly payments remain constant unless there are changes in your property taxes or homeowners insurance, which can affect your escrow payments. Fixed-rate mortgages are commonly available in terms ranging from 15 to 30 years.
Adjustable-Rate Mortgage (ARM)
An adjustable-rate mortgage has a variable interest rate, making mortgage calculations a bit more complex. The interest rate changes periodically, which affects your monthly payment. Mortgage calculators are particularly useful for ARMs, allowing you to explore best- and worst-case scenarios to determine if this type of mortgage fits your budget.
Reverse Mortgages
A reverse mortgage is designed for retirees who want to access their home equity without selling their home or making monthly mortgage payments. Instead of making payments, interest accrues on the loan, which is paid off when the borrower no longer lives in the home.
15-Year Mortgages vs. 30-Year Mortgages
When deciding on your mortgage term, you can choose between a 15-year or 30-year mortgage. A 30-year mortgage offers lower monthly payments but results in more interest paid over the life of the loan. In contrast, a 15-year mortgage has higher monthly payments but allows you to pay off the loan faster and save on interest overall.
Mortgage Interest Rates
Mortgage interest rates have been a major topic of discussion since the pandemic. During the shutdown, rates dropped to levels not seen in decades, but they have since risen back to more typical levels, which some may perceive as high.
When deciding whether to invest in a property, the mortgage interest rate is a crucial component in the mortgage formula. While it’s not the only factor to consider, it is an investment cost that can impact your overall profits. Therefore, it’s wise to shop around to secure the lowest possible rate.
What Is a Debt-to-Income Ratio?
When lenders evaluate your eligibility for a mortgage loan, they consider your credit score, income, and debt-to-income (DTI) ratio.
The DTI ratio compares your gross monthly income to your monthly debt payments. An ideal DTI is around 36%, but many lenders may allow a higher ratio for property investors, particularly those with more experience.
How Does a Debt-to-Income Ratio Affect Affordability?
Your DTI ratio directly impacts your affordability. The more of your income that goes toward monthly debt obligations, the harder it can be to manage your payments if the market takes a downturn. For instance, if you borrow up to your maximum limit and face a higher vacancy rate, you could find it challenging to cover your expenses. It’s best to keep your DTI ratio at a manageable level to protect your financial stability.
How a Larger Down Payment Affects Your Mortgage Payment?
When investing in a property, making a larger down payment can have several benefits. A higher down payment makes it easier to get approved for financing and reduces your monthly mortgage payment. Additionally, some lenders might offer a lower interest rate if you have more equity in the property.
Tips for Managing Your Mortgage Payments Throughout Your Loan Term
After calculating your mortgage payment using a formula or calculator and getting approved for the loan, it’s crucial to manage your payments effectively, especially if you own multiple properties. Here are some helpful tips:
- Set a Budget: Ensure your monthly mortgage payment fits within your budget, and consider the area’s average vacancy rates. This will give you a clearer picture of your expected income.
- Maintain an Emergency Fund: As a landlord, you are responsible for all repairs and routine maintenance on the property. Keeping an emergency fund will help you cover these expenses and ensure you can still afford your monthly mortgage payments.
- Make Extra Payments: If possible, make additional payments on your mortgage to reduce the loan term and save on interest costs over time.
Mortgage Payment FAQs
Understanding how to calculate your mortgage payment is crucial. Here are answers to some common questions investors have about mortgages:
Why Does Your Mortgage Payment Occasionally Increase?
Even if you have a fixed monthly payment and interest rate, your mortgage payment might still change. This can happen if your property taxes or homeowners insurance premiums increase. Mortgage companies conduct an annual escrow analysis to ensure your payment covers these costs adequately. If not, your payment may be adjusted to meet the new requirements.
How Do Lenders Determine How Much You Can Borrow?
Lenders evaluate several factors to decide how much you can borrow. They review your credit score, credit history, income, employment, and assets. They also calculate your debt-to-income ratio and compare your intended down payment to the minimum requirements of each loan program. Lenders need to be confident that you can afford the mortgage payments before approving the loan.
