Understanding Home Loans
How Monthly Payment is Calculated
Your monthly mortgage payment (principal & interest) is calculated using the standard loan amortization formula:
M = P × [r(1+r)^n] / [(1+r)^n - 1]
Where:
M = Monthly payment
P = Principal loan amount (home price - down payment)
r = Monthly interest rate (annual rate ÷ 12)
n = Number of payments (years × 12)
Where:
M = Monthly payment
P = Principal loan amount (home price - down payment)
r = Monthly interest rate (annual rate ÷ 12)
n = Number of payments (years × 12)
Components of Your Monthly Payment (PITI + Extra)
- Principal: The amount that reduces your loan balance. Early payments are mostly interest; later payments are mostly principal.
- Interest: The cost of borrowing money. Calculated on remaining loan balance, so it decreases over time as principal is paid down.
- Property Taxes: Typically 1-2% of home value annually, collected monthly and held in escrow by lender to pay your local government.
- Insurance: Homeowners insurance protects against damage/loss. Average $1,000-2,000 annually, varies by location and coverage.
- PMI (Private Mortgage Insurance): Required if down payment < 20%. Protects lender if you default. Typically 0.5-1.5% of loan amount annually. Can be removed once you reach 20% equity.
- HOA Fees: Homeowners Association fees for condos/planned communities. Covers maintenance of common areas, amenities. Ranges $100-700+ monthly.
Down Payment Strategies
20% Down Payment (Ideal)
Benefits:
- No PMI required (saves $50-200+ monthly)
- Better interest rates from lenders
- Lower monthly payments
- Instant 20% equity in your home
- More competitive offer to sellers
Less Than 20% Down Payment
Considerations:
- PMI required (0.5-1.5% of loan annually)
- Higher monthly payments
- May qualify for FHA loan (as low as 3.5% down)
- Keeps more cash for emergencies/improvements
- PMI can be removed after reaching 20% equity
Loan Term Comparison
30-Year Fixed
- Lower monthly payments
- More budget flexibility
- More interest paid over life
- Slower equity buildup
- Best for: maximizing cash flow
15-Year Fixed
- Higher monthly payments
- Much less total interest
- Own home faster
- Rapid equity buildup
- Best for: long-term savings
Example Comparison ($300k loan at 6.5%):
30-year: $1,896/month, $382,633 total interest
15-year: $2,613/month, $170,451 total interest
Savings with 15-year: $212,182 in interest!
30-year: $1,896/month, $382,633 total interest
15-year: $2,613/month, $170,451 total interest
Savings with 15-year: $212,182 in interest!
How to Reduce Total Interest Paid
- Make biweekly payments: Pay half your monthly payment every 2 weeks = 13 full payments per year instead of 12
- Pay extra toward principal: Even $100/month extra can save tens of thousands in interest
- Make one extra payment per year: Reduces 30-year loan to ~26 years
- Refinance when rates drop: Lower rate can save significantly over loan life
- Round up payments: Pay $2,000 instead of $1,896 - small increase, big impact
The 28/36 Rule - How Much House Can You Afford?
Front-End Ratio (28%):
Your monthly housing payment (PITI) should not exceed 28% of gross monthly income.
Back-End Ratio (36%):
Total debt payments (housing + car + student loans + credit cards) should not exceed 36% of gross income.
Example: $6,000/month income → max $1,680 housing, max $2,160 total debt
Your monthly housing payment (PITI) should not exceed 28% of gross monthly income.
Back-End Ratio (36%):
Total debt payments (housing + car + student loans + credit cards) should not exceed 36% of gross income.
Example: $6,000/month income → max $1,680 housing, max $2,160 total debt
Additional Homebuying Costs to Budget For
- Closing costs: 2-5% of purchase price ($6k-$15k on $300k home)
- Home inspection: $300-500
- Appraisal: $300-500
- Title insurance & search: $500-2,000
- Moving expenses: $1,000-5,000
- Immediate repairs/updates: Budget 1-2% of home price
- Furniture & appliances: Varies widely
- Ongoing maintenance: Budget 1% of home value annually
💡 Pro Tips
- Get pre-approved before house hunting - know your budget and strengthen offers
- Shop around - compare rates from 3-5 lenders, even 0.25% difference saves thousands
- Consider all costs - don't just focus on monthly payment, calculate total cost
- Keep emergency fund - aim for 6 months expenses even after down payment
- Factor in maintenance - older homes may need 2-3% annual maintenance budget
- Review your mortgage annually - refinancing opportunities, PMI removal eligibility