When buying a home and entering a mortgage commitment one needs to be confident about being able to make monthly payments, likely much larger than rental payments replaced, due to additional payments for property taxes, home owners insurance and possible private mortgage insurance. Further, home purchases need sizable upfront funds for down payment and settlement charges such as setting up an ESROW account, Title insurance, Surveys and miscellaneous charges. We assess both these upfront expenses, and the subsequent monthly payments you will have to make when you purchase a home.
Earmarking Income for Mortgage and Related Payments
In our page titled “How much do you really make?” we had mentioned a thumb-rule often offered by advisors that earmarking 28% of your Annual Household Income, before taxes or deductions, to Mortgage and related payments may be about right. Factors such as unsteady income, your inclination to spend or to save, and the magnitude of your income could affect what you want to set aside each month for your mortgage and related payments. The first box of the calculator allows you to choose larger or smaller percentages than 28% of your income for such payments.
Other details to be entered in this box are the annual household income, the term of the loan, the annual nominal interest and any points associated with the interest rate offered by the lender. This calculator applies to the standard fixed rate loans. As a default, we have an annual income of 90K, the percent of Income which can be applied to Mortgage and related payments of 28%, a 30 year loan term and a 4% interest rate with no points. The last row in this box computes the effective interest rate, which is slightly higher at 4.07% due to monthly compounding.
The second box of the calculator computes the likely breakdown of the periodic payments and collects in the last box the available savings a user can apply to upfront costs. The first row in the second box computes the estimated total mortgage related payments you can make annually, based on percent you can apply to these payments and your annual income. The next two rows allow you to enter an estimated percent of that amount that you might use for home owners insurance and property tax. These corresponding dollar amounts are in the succeeding rows. Property taxes (PT) and home owners insurance (HOI) can vary based on the location where you intend to purchase and the user is advised to change the percentages till the corresponding dollar amounts are in the ballpark. The annual property taxes are usually in the sale listing provided by the real estate agent. The savings available for annualized mortgage payments alone (and any Private Mortgage Insurance) is computed as what remains after PT and HOI. This is then computed as a monthly figure in the next row. The last cell in this block of the calculator allows the user to enter the actual savings/funds available for upfront payments at closing. The user should at least enter a number larger than an amount to cover settlement costs, a 3% down-payment and any payment for points. An approximate estimate of that minimal amount is provided in the previous row. The default scenario has savings available of $40K which is more the minimum of $7,700.
How much Home?
Now you have provided all you need to compute ‘How much Home you can buy?”, and your upfront and continued payments after that. This third box computes the price of that home a person with a 90K annual household income having 40K for closing costs, as $308,001 – well TA DA!! This can change with some customization to your context achieved by changes to the yellow and blue cells in the next block of the calculator.
Payments at Closing
This next box with the upfront payments allows changes to the ESROW account deposit and upfront payment of HOI and PT coming due a little after closing, and, not covered by the ESROW. Both of these yellow cell amounts can be changed by the user. The latter payment can depend on the relative time of purchase, move-in and when the PT and HOI are due, and could also include pre-paid interest before the first mortgage payment. Further, the user can enter a percentage different from the default 0.4% and 0.2% to get better estimates of the dollar costs of title insurance and the other noted miscellaneous costs. The total of 40K in the default scenario for the upfront costs agrees with the 40K of funds available to support the transaction. Note that the down payment of $34,057 is 11.06% of the home price and falls short of the 20% that would help one avoid Private Mortgage Insurance (PMI), an insurance premium one pays, to assure the lender recovery of the entire principal in the event of a default. Thus, for down payments less than 20% the borrower would likely have to pay PMI. Additionally note that a lower interest rate offer in exchange for pre-payment of points should not be considered as the payments of points would further reduce the percent down payment, increasing your PMI premiums.
The final block of the calculator has the PMI payment of $204 per month in addition to PT, HOI and the mortgage payments. Note that the PMI needs to be paid only while your principal exceeds 80% of the home price. These mortgage related payments sum to a total of $2101 monthly to the ESROW account, which, makes these payments on your behalf. The PMI can sometimes be paid upfront or annually outside the ESROW. The PMI is computed approximately here as 0.1% of the financed amount for every percent over the Loan to Home Value (LTV) of 80%. The actual PMI rate will depend on your credit history and other considerations depending on your insurer. The PMI rate computes using our linear approximation as 0.894% for the 88.94% LTV in our default example.
Note that if one has 95K instead of 40K in savings available, we increase to 5% and 30% the proportion of these savings for HOI and PT to reflect likely increases in these. Then with the same annual income of 90K and the 28% earmarked for Mortgage payments, as in the default, a home worth $378,334 would be a viable purchase. Larger by $70,333 through an increase in funds at closing by $55,000. Note the additional funds allowed for the payment of points in exchange for a lower interest rate of 3.75%. Online calculators at bank sites can help determine if the trade-off between pre-payment of points and the lower interest rate offered is worthwhile.
First, edit the blue cells in the spreadsheet and enter your data. The yellow cells are the author’s pre-filled estimates based on your blue cell entries. You may over-write these yellow cells, on entering all blue cells, to enter your actuals instead of the pre-filled estimates. Computed data are in the white cells. Refresh the page before entering a new set of blue cell values.