Before you set out to buy a home, one of the most important questions that you must ask and answer is how much can you afford to spend. In order to answer that question accurately, you need to get a fair idea of your income and expenditure. You need to figure out your long-term financial goals and know what amount of your income you are going to need to achieve them. We have already discussed this in another section. In this section we will talk about the common costs of buying and owning a home.
Mortgage Payments – Your largest home ownership cost
Your monthly mortgage payment is going to be the single largest cost of owning a home. Later on in other sections we will discuss choosing the best kind of mortgage that suits your financial circumstances the best.
Mortgage loans in the United States are typically 15 year or 30 year mortgages. Suppose you are purchasing a home for $250,000, and as is advisable, you have made a 20% down payment, you will need to take a home loan for $200,000. Here is what your monthly mortgage payment is going to be like under both the 15 year and 30 year mortgage term.
$200,000, 15 year mortgage at 7% = $1800 approximately a month.
$200,000, 30 year mortgage 7.25% = $1366 approximately.
As is obvious from the above calculation, the interest rate that is chargeable on a 30 year mortgage is slightly higher than the 15 year mortgage. This is almost always the case because the risk to the home loan lender is more for a longer mortgage term. Longer mortgage term means that there are more opportunities for something to go wrong with the finances of the borrowers and for him to default. The payment on the 15 year mortgage is higher because you are attempting to pay off the home loan 15 years earlier as compared to the 30 year mortgage.
You should not let the higher payment on the 15 year home loans to be a detergent in choosing it because by paying it off earlier you are not only going to get rid of your financial obligation that much quicker but are going to save a ton of money on interest as well. Taking the example above, this is the difference between the amount of interest that you will pay for a 15 year and a 30 year mortgage respectively.
Mortgage Term – Total Payment – Interest
15 Year 324000 124000
30 Year 491760 291760
As you can see from the above example, the amount of interest that you end up paying for a 30 year mortgage as compared to the 15 year mortgage is more than double. This should not come as a surprise because the time that you are going to take to pay off the mortgage is also double.
You should know that in the earlier years of keeping your home loan, almost all of your monthly payment is going to go towards payment of your interest. The ratio of the monthly payment that is divided between interest and principal payment will bend more towards principal payment as the mortgage loan progresses and in the later years of the mortgage you will rapidly begin to pay down your loan balance.
With an increase in the interest rate, the time required to pay off of the loan also increases. At 10% interest paying off the loan takes almost 24 years in a 30 year mortgage and at 14% interest rate paying off of the home loan takes over 25 years for the same mortgage term.
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