What’s in a Mortgage Loan Payment
A monthly mortgage payment is made up of many different elements. When you write your monthly mortgage check, you aren’t just paying toward the principal of your loan. The monthly mortgage payment is also paying interest, taxes, insurance, and possibly other fees. Before we look at the components of a mortgage loan payment let us review the components of the home loan first.
The home loan starts with the principal amount of the loan. The sum of money you initially borrow is the principal balance. Now you look at how long you will have to repay the loan, this is the term. The term of the loan is its duration or the length of time for repayment. Which brings us to the next key term, interest. The interest rate is the mortgage rate at which the lending institution charges you for borrowing the money. Once we have the basics of the interest rate charged, principal balance borrowed and the length or term of the loan we can calculate the monthly mortgage payments.
Amortization is a lending term used to define the repayment of a debt over time. In the early stages of a loan most of the payment will go towards paying the interest on the home loan. In the later life of the loan the monthly payment goes more towards reducing the principal balance. A mortgage’s amortization schedule can provide a detailed look at precisely what portion of each monthly mortgage payment is dedicated to each component of principal and interest.
Let’s take a look at the components of a house payment, and see where your money goes each month.
Principal and Interest Payment – This payment goes towards paying off the loan amount, or principal, and the interest that has accrued over the time period of the loan. You can use a mortgage loan calculator to help you determine possible P&I payment amounts as you consider a loan. You an also look at how much interest and principal repayment you will have over the life of the loan.
Real Estate Taxes – Your mortgage payment will also include one twelfth of the annual real estate taxes each month. Real estate taxes are calculated by the local government taxing authority, not the mortgage company, the lender collects the payments and holds them until the taxes are due to be paid. Lenders pass these taxes on to you monthly, because if they are not paid, the government can have a lien placed against the house. If the owner of the home fails to pay real estate taxes, the government can sell the property in order to collect back taxes. Escrowing these taxes ensures the mortgage lender that they will be paid.
Homeowners’ Insurance – Most mortgage lenders require a homeowners insurance policy for at least the amount of the home itself. The mortgage company often require that the first year of homeowner’s insurance be paid in full at closing. The mortgage company then continually stays ahead on the premium by escrowing 1/12 of the insurance payment with the monthly mortgage payment, which eliminates lapses in coverage on the part of the homeowner. Note that having only enough coverage to cover the value of the mortgage only protects the lender’s interests should the home burn or fall to some other catastrophe.
Private Mortgage Insurance Escrow – If the loan has a loan to value ratio of over 80%, this mortgage insurance covers the lender in case the mortgage holder defaults on the loan. If a down payment of 20% or more is put down, then this is not required. PMI coverage may be dropped once the value of the loan is at or under 80% loan to value. The mortgage insurance costs can be paid in a variety of methods including lender paid insurance in which there is an increase in the interest rate to cover the mortgage lenders cost. The lower the down payment, the greater the loan risk and the more expensive the mortgage insurance will be.
Homeowner’s Association Fees – If homeowner’s association fees are mandatory, than one twelfth of these fees may be added to the monthly mortgage payment. The process of adding homeowner’s association fees to the monthly payment is becoming very uncommon and the responsibility for the payment rests solely with the homeowner.
While principal, interest, taxes and insurance comprise a typical mortgage payment, some borrowers opt for mortgages that do not include taxes or insurance as part of the monthly payment. With this type of loan payment, referred to as waiving escrows, borrowers have a lower monthly payment, but must pay the taxes and insurance on their own.
Balloon Mortgages
Balloon loans have many of the same features of a fixed rate mortgage with one major exception; at the end of a predetermined amount of time the remaining balance of the loan is due in full. These home loans offer a level payment feature during the term of the loan, but as opposed to the 30 year fixed rate mortgage, balloon loans do not fully amortize over the original term. In a balloon mortgage loan contract, the borrower agrees to make a lump sum payment of the loan balance at the end of a certain period, typically two to ten years. At the end of the original term the home loan borrower must pay off or refinance that remaining mortgage balance. That is, the payment is calculated over 30 years but the balance must be repaid sooner.
Balloon loans can have many different maturities or terms, but most balloons that are first mortgages have a term of 5 to 7 years. Though the term of the home loan is 5 or 7 years, the payment calculation is based on a longer term, generally 30 years but can also be for 15 or 20 years. Sometimes theses home loans are often viewed as close substitutes for an adjustable rate mortgage. They have an initial fixed interest rate period of five or seven years which shortens the interest rate risk for the mortgage company and thus the mortgage rate to the borrower the result is that these home loans generally have a lower mortgage rate than that of a fully amortizing 30 year fixed rate home loan.
Balloon loans can keep the monthly payment lower than standard 30 year fixed rate mortgages but these home loans also have risks. The balloon loan will come due and if you don’t have sufficient funds to pay off the balance or a substitute loan in place this can spell trouble since the borrower will now be in default on the mortgage loan. The general rationale for incurring the added risk of the balloon feature is that since the vast majority of mortgages will never be paid in full because very few people remain in a home for the full length of their mortgage.
When choosing a balloon loan be sure you fully understand the time frames involved and the terms and conditions of repayment or conversion. This loan is generally used by borrowers who are fairly certain they will be moving from the house that they have the balloon loan on.
Avoid Over Paying Mortgage Junk Fees
Additional fees for obtaining a home mortgage that serve no useful purpose are called junk fees. Most fees associated with originating your loan are third party fees necessary to obtain a loan approval, examples are appraisal fee, credit report fee and flood certification fee. Fees that are not necessary and are paid directly to the originating mortgage company are junk fees. Most junk fees do have one main purpose – increase the profits of the firm arranging the loan in addition to the money that make on the mortgage rate.
In order to ascertain which fees are junk and potentially profiting the originator at your expense, you have to compare the costs of the loan. One of the biggest obstacles in obtaining the least expensive loan is being able to accurately compare loan quotes. A mortgage rate quote by itself is of little value. You need the interest rate, term, costs and loan program. Clearly there is no point in comparing the rate and cost of an adjustable rate loan to a fixed rate loan with different terms. Before you attack the junk fees and question the loan officer, evaluate the different loan products and then get a mortgage rate quote with a complete break down of costs.
When you’re going through the process of applying for the loan, you will be given a variety of documents. Mandatory disclosure documents that are given out with every mortgage application make the evaluation exercise much simpler. One such document is the Good Faith Estimate that covers all the costs associated with obtaining the home loan. Federal law requires all mortgage lending institutions to provide a good faith estimate of closing costs within 3 days of the borrower filling out an application. With the Good Faith Estimate you should also receive a truth in lending notice. This is another federally mandated disclosure that spells out the mortgage interest rate over the life of the loan. These two disclosure documents, combined, are the key to evaluating the home loan fees and costs.
On the Good Faith Estimate form the costs of the loan will be itemized by category. Some lenders will charge more than others in various categories. The category of the fee is often not as important as the total amount of the fees. As an example, if lender A charges a $400.00 processing fee and lender B does not, lender A is not necessarily the better deal if lender A charges a $1000.00 origination fee and lender B charges no origination fee. Compare total costs and groups of costs as opposed to focusing on any particular fee that jumps out as being a junk fee.
The first group of fees on a Good Faith Estimate is the fees to cover the lender or originating mortgage lender for their services. This group is the category of fees with the greatest amount of room for negotiation. Here you find the charges for origination fee, discount points, appraisal fee, credit report fee, processing fee, document preparation fee, underwriting fee and perhaps other related charges. Junk fees are almost always thrown into this group. The key is compare similar loans with more than one mortgage lender. The total fees are more important than how any lender breaks them apart.
The second group is the prepaid charges. There is really no room to overcharge here, so negotiating should be irrelevant. On a purchase, the homeowners insurance may go here and the interim interest for the time you have the loan until the start of the first payment cycle would be disclosed here.
The third group is reserve or escrow deposits. These deposits are dictated by the taxing authorities and the time of the closing. Escrow are fairly well regulated, it would be difficult to find abuse in this section.
The fourth section is the title and closing charges. It is not often you will find a mortgage company that will negotiate the title charges. The primary reason being that the title company or closing company is not related to the mortgage company in most cases. If the title company is related, negotiate this fee as low as possible. Even if they are unrelated, it never hurts to complain about the amount of the charges for title insurance and closing fees.
Even though negotiating and asking questions about the closing costs can be time-consuming, you may be able to save hundreds, or even thousands of dollars at closing. Get another rate quote if necessary from a competing mortgage company. Compare the figures. Ask if the fees can be reduced. Don’t be intimidated; there are an abundance of mortgage companies looking for your business. If the loan officer won’t help you, move on and find one that will. Asking for the best mortgage rate and best terms at the lowest cost is your right.
When you get to the closing make sure the fees that were explained to you at the time of the application and placed in writing on the good faith estimate are equivalent. The purpose of the good faith document is to let you know what loan fees that you may be paying at closing. At the closing you will receive a HUD-1 settlement statement to review and sign, be sure the fees on this document are the same as the fees in the good faith estimate. If you want to question any of the fees on the HUD-1 settlement statement, do it without delay. You may feel as if you shouldn’t question these fees, but you have a right to do so and you should understand all aspects of this process with its cost.
Shop wise. Don’t accept the first offer that comes your way. Closing costs are necessary evils of closing a mortgage for either a home purchase or refinance. However, at times, they are used to increase the income of the mortgage originator or lender in a deceptive manner. It’s the job of a good loan officer to explain all of the costs to you and expect that you may shop around. A good loan officer who does his or her job right should expect that of educated borrower and accept the competition. Any amount of money that you can save at closing will be worth it.