A mortgage payment is typically a homeowner’s most significant recurring financial commitment, so knowing what it entails can help you plan and budget wisely. Getting pre-approved before starting your house hunt is essential because it will help streamline the home-buying process and give you a clearer idea of what you can afford. Let’s dive into the components of a mortgage payment and the reasons pre-approval is a critical first step.
What Makes Up a Mortgage Payment?
A standard mortgage payment consists of four primary components, commonly referred to as PITI: principal, interest, taxes, and insurance.
- Principal
The principal is the amount you borrow from a lender to purchase the home. It represents the home’s price minus your down payment. Each payment you make reduces this principal balance, gradually increasing the equity you have in your home. - Interest
Interest is the cost of borrowing money from the lender, calculated as a percentage of your remaining loan balance. The interest rate you secure plays a significant role in determining your overall payment amount, which is why it is so important to secure a favorable rate. - Taxes
Property taxes are imposed by your local government and typically cover services like public schools, infrastructure, and emergency services. Your lender usually collects these taxes as part of your mortgage payment and places them into an escrow account. The lender pays the taxes on your behalf when they’re due. - Insurance
Homeowners insurance is essential to protect your property against damage, theft, and other risks. In addition, if your down payment is less than 20% of the home’s value, you’ll likely be required to pay private mortgage insurance (PMI). PMI protects the lender in case you default on the loan.
An escrow for a mortgage is a separate account set up by your lender to manage payments for property-related expenses such as property taxes and homeowners insurance. When you make your monthly mortgage payment, a portion of it is deposited into the escrow account, ensuring there are sufficient funds to cover these expenses when they come due. The lender then uses the funds in escrow to pay your taxes and insurance on your behalf. This arrangement provides convenience and ensures that these critical payments are made on time, reducing the risk of penalties or lapses in coverage. Escrow helps homeowners manage their larger, periodic expenses by spreading them out evenly over the year as part of the mortgage payment.
In the early years of your loan, a larger share of your payment goes toward interest, with only a smaller amount reducing the principal balance. Over time, as you pay down the loan, this shifts, and more of your payment is applied to the principal. If your loan includes escrow for property taxes and homeowners insurance, a portion of your monthly payment will also be set aside to cover these expenses. If applicable, you may also pay private mortgage insurance (PMI), which protects the lender if you default.
Other potential components of a mortgage payment may include:
- HOA Fees: If your home is in a community with a Homeowners Association (HOA), you may have to pay HOA fees to cover shared amenities and maintenance.
- Mortgage Insurance Premium (MIP): If you have an FHA loan, you’ll also need to pay for MIP, which is similar to PMI for conventional loans.
It is important to note that while your mortgage payment is a set amount, if you are paying your taxes and insurance with an escrow account, your payment amount may change if you don’t address any shortages in your escrow account. This is something to keep an eye out for, as they will usually notify you of any upcoming changes and allow you to pay any shortage separately so that your mortgage payment stays the same.
Why Is It Important to Get Pre-Approved Before Shopping?
Know Your Budget
Getting pre-approved gives you a clear understanding of how much you can afford. The lender will review your financial situation—your credit score, income, and debt—to determine the loan amount you qualify for. Without pre-approval, you risk falling in love with a home outside your budget or having your loan application rejected during the process.
This quick formula can help you get an idea of what your monthly budget will be.
- Identify your monthly payments toward debt (credit cards, auto loans, student loans, etc.)
- Add that to your preferred monthly house payment (If you’re unsure, make a best guess.)
- Divide that number by your monthly income before taxes.
- If the decimal you arrive at is under 45%, you are in good shape.
- If the decimal is over 45%, decrease that house payment and do the same calculation until you can get below 45%.
- Whatever the house payment figure is that gets you to 45% will likely be your maximum monthly payment on your pre-approval.
If you’re ready to run the numbers, give us a call. We’ll help you figure out precisely what you can afford.
Strengthens Your Offer
In competitive real estate markets, sellers are more likely to accept offers from buyers who are pre-approved. Pre-approval signals that you’re a serious buyer with financing already in place, giving you an edge over buyers who may not have taken this step.
We can’t tell you how many times our Homestead clients beat other competing offers simply because they were pre-approved by us – a local mortgage lender. Here are two main reasons why sellers care about who the lender is on the other end of the transaction:
Thoroughness & Accuracy: The real estate community is tight-knit, so our pre-approvals must be accurate to ensure we do not tarnish our reputation as a credible lender. Big-bank online lenders do not have personal relationships with listing agents in your town, meaning they have less to lose if the financing falls apart in the middle of the transaction.
Communication: We don’t follow regular banking business hours, and customers, sellers, and real estate agents appreciate that. We can help you get approved entirely from your phone while you’re on the go. Many circumstances can arise throughout the process, and all parties must be able to communicate on nights and weekends to get direct answers without dealing with a frustrating automated system.
Save Time and Help Improve Your Negotiating Power
By getting pre-approved, you streamline your home search. You won’t waste time looking at homes outside your price range, and you can move quickly when you find the right property. It also helps avoid last-minute surprises during the closing process, as many potential issues will be identified upfront.
With a pre-approval letter in hand, you have more negotiating power. Sellers will see you as a credible buyer, giving you leverage in price negotiations and when requesting concessions or repairs.
Locks In Interest Rates
In many cases, pre-approval allows you to lock in an interest rate for a specified period. This is especially valuable if rates are on the rise, as it can protect you from rate increases while you shop for a home.
If you’re preparing to buy a home, it’s a good idea to make sure your credit is in tip-top shape. Better credit scores often mean better interest rates – so it’s best to do all you can to ensure your credit is good. Learn more about what makes up your credit score, as well as some things you can do to help improve your score if needed.
Conclusion
A mortgage payment is made up of several components that collectively contribute to the overall cost of homeownership. Understanding these components helps you plan your budget and make informed decisions. Getting pre-approved before you start shopping for a home not only clarifies what you can afford but also positions you as a serious buyer in the eyes of sellers. By preparing in advance, you’ll be better equipped to navigate the complex world of real estate and make a successful home purchase. Reach out today to get answers to your questions and get pre-approved.
*Example is based on a 780 credit score, and 5% down payment on a 30 year term and a rate of 6.25% and 6.60% APR. The information provided by Homestead Financial Mortgage is for educational purposes only. Products and interest rates are subject to change at any time due to fluctuating market conditions. Actual rates available may vary based on a number of factors, including credit rating, down payment, loan type, and documentation provided.