- Borrowing to buy a home is very common.
- You'll likely have to pay large mortgage payments every month.
- You should make sure you understand how much your loan will cost you.
Don't take out a mortgage loan without understanding the costs.
If you are buying a home, chances are good you'll be doing it using a mortgage. Mortgages are secured loans designed to help you buy real estate. They generally have lower interest rates than unsecured loans.
Although home loans may be a low-cost borrowing option, your mortgage is probably going to be your biggest debt. And you don't want to get in over your head and borrow more than you should -- even if you're tempted by the perfect home.
To make sure the mortgage loan you take out is the right one for you financially over the long term, it's helpful to understand the two numbers that determine the price of borrowing.
1. The interest rate
Interest is what you pay for the privilege of being able to access a lender's money to buy your home. If you are charged a higher rate, you pay more to borrow than if you have a lower one.
Interest is charged as a percentage of your outstanding balance. Your rate could be fixed or adjustable. Typically, it's best to choose a fixed-rate loan so your payments don't change over time. Fixed-rate loans provide predictability so you know your costs upfront.
Your interest rate affects both the size of your monthly payment as well as the total costs of your loan over time. When you borrow, the goal is to pay back the entire principal balance -- plus interest -- on a set schedule. This means your payments are calculated based on:
- The amount of interest accrued that must be paid
- The amount of your principal needed to pay your full balance on schedule
If you get stuck paying a higher rate, more of each payment must go to covering these financing charges. But you still need to pay your balance off within the designated time, so your total monthly payment will climb higher.
Say, for example, you took out a 30-year fixed-rate mortgage loan for $100,000 at 5% versus at 3%. Your monthly principal and interest payment would be $422 at 3%, but it would be $537 at 5%.
You'd be paying down the same $100,000 principal with both loans, but your monthly costs and total borrowing costs would be much higher with the elevated rate.
2. The amount borrowed
The amount you borrow also affects mortgage costs because if you take out a larger loan, you have a higher principal balance to pay back and will owe more in interest.
To continue the above example, what would happen if you borrowed $500,000 at 5%, rather than $100,000? You would obviously have to pay back $500,000 in principal rather than just $100,000. But your monthly interest costs would also be a lot higher since your financing costs equal a percentage of your outstanding balance.
If your loan was for $500,000, your monthly payments would be $2,684 rather than $537. That's a huge difference. You'd also pay a lot more total interest over time. In fact, it would cost you $966,279 in total to repay your mortgage, instead of $193,256 if you borrowed just $100,000.
If you want to keep monthly payments and total borrowing costs down, your best option is to try to borrow as little as possible and aim for the lowest interest rate loan you can qualify for. You can find that by shopping around and comparing mortgage quotes from different lenders before you commit to borrow.
Our Research Expert
We're firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.
The Ascent is a Motley Fool service that rates and reviews essential products for your everyday money matters.
Copyright © 2018 - 2023 The Ascent. All rights reserved.