by Maurie Backman | Updated July 19, 2021 - First published on Oct. 22, 2020
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It's important to know exactly what you're signing up for when you apply for a mortgage.
When you shop around for a mortgage, you'll compare different interest rate offers to see which is the most competitive. From there, you can run some calculations to see what your monthly principal and interest payments will look like. But what many homebuyers don't realize is that certain factors can push their monthly payment higher than they'd anticipated. Here's why that might happen to you.
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You don't always need to make a 20% down payment on your home, even though that's the standard mortgage lenders tend to demand. But if you put down less than 20% of your home's purchase price, you'll generally get stuck paying private mortgage insurance, or PMI. PMI is a premium that's tacked onto your monthly mortgage costs to protect your lender in case you fall delinquent on your payments. It's generally equal to up to 1% of your loan amount each year. For a $200,000 mortgage, you could be looking at $2,000 a year, or about $167 a month, in PMI.
It costs money to get a mortgage. You'll need to pay application fees, recording fees, and a host of other fees when you finalize a home loan. Those fees are known as your closing costs, and they generally equal anywhere from 2% to 5% of your loan amount. For a $200,000 mortgage, you may need to pay $4,000 to $10,000 in closing costs.
Now you have a couple of choices with regard to these costs: You can pay them at closing, or roll them into your loan. Many borrowers opt for the latter. But if you roll those costs into your mortgage, your monthly mortgage payments will be higher.
Mortgage points are a fee you pay in exchange for a lower mortgage rate, and each point costs 1% of your loan amount. For a $200,000 mortgage, one point equals $2,000 and will generally save you one-quarter of a percent on your rate. Or, to put it another way, buying one mortgage point could take a 3% rate down to 2.75%.
Buying points can be a good idea and save you money over time. But like closing costs, you'll either need to pay for them up front or roll them into your loan. And if you go the latter route, it'll drive your monthly mortgage payments up.
When you buy a home, it's important to factor your mortgage costs precisely into your budget, so you'll need to know how much you'll pay. You can do some initial calculations to see how much your principal and interest will cost you. But don't forget that there are other factors that could drive your payments up, like the ones above.
Also, remember that you'll have to cover property taxes, homeowners insurance, and, in some cases, homeowners association fees on top of your mortgage payments. Sit down and make a list of every expense. That way you won't be left scrambling when those bills start coming due.
Chances are, interest rates won't stay put at multi-decade lows for much longer. That's why taking action today is crucial, whether you're wanting to refinance and cut your mortgage payment or you're ready to pull the trigger on a new home purchase.
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