So the question then is where to begin?  Well, let's start with house payments.

 

When you find a house you'd like to purchase there are three major things you have to keep in mind about the actual costs of the house:

 

1.  Principle and Interest payments

2.  Tax and Insurance costs (a.k.a. "escrow")

3.  Closing costs

 

 

The first thing to consider is most likely going to be the thing that costs you the most during the life of your loan.  The principle and interest is simply the amortized schedule of payments that is a direct correlation of your purchase price and your interest rate.  Keep in mind that the majority of your payments will go towards interest in the beginning of your loan.  That's because the bank wants to be paid first, so when you present them with, for instance, a $1000 mortgage payment, the first 80+% of it will go to interest, the other 20% will go towards principle.  Which means it will take a while to finally get the wheels rolling on paying off your house.

 

Here is an example of what your first year and last year of mortgage payments would be if you were to get a traditional 30 year fixed rate mortgage on a $100,000 loan at 6.5%.  It is also worth mentioning that amortization tables such as these assume that payments are made the same day each month.  Payments made earlier or later would result in minor differences in principal/interest allocations.

 

The montly payment would for our example would be $632.07; just look how it is split between Principal and Interest in the first year as compared to the last (30th) year.  Of the first payment, only $90.40 of the $632.07 (or 14%) goes to the principal.  On the last payment, $626.46 of the $632.07 (or 99%) goes to payoff the principal.

 

Pmt	Principal	Interest	Cum Prin	Cum Int	Prin  Bal
1	90.40	541.67	90.40	541.67	99909.60
2	90.89	541.18	181.29	1082.85	99818.71
3	91.39	540.68	272.68	1623.53	99727.32
4	91.88	540.19	364.56	2163.72	99635.44
5	92.38	539.69	456.94	2703.41	99543.06
6	92.88	539.19	549.82	3242.60	99450.18
7	93.38	538.69	643.20	3781.29	99356.80
8	93.89	538.18	737.09	4319.47	99262.91
9	94.40	537.67	831.49	4857.14	99168.51
10	94.91	537.16	926.40	5394.30	99073.60
11	95.42	536.65	1021.82	5930.95	98978.18
12	95.94	536.13	1117.76	6467.08	98882.24

 

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349	592.41	39.66	93270.07	127322.36	6729.93
350	595.62	36.45	93865.69	127358.81	6134.31
351	598.84	33.23	94464.53	127392.04	5535.47
352	602.09	29.98	95066.62	127422.02	4933.38
353	605.35	26.72	95671.97	127448.74	4328.03
354	608.63	23.44	96280.60	127472.18	3719.40
355	611.92	20.15	96892.52	127492.33	3107.48
356	615.24	16.83	97507.76	127509.16	2492.24
357	618.57	13.50	98126.33	127522.66	1873.67
358	621.92	10.15	98748.25	127532.81	1251.75
359	625.29	6.78	99373.54	127539.59	626.46
360	626.46	3.39	100000.00	127542.98	0.00

 

 

 

 

Unfortunately that's not all it takes to own a house.  The government wants it's cut, as do the insurance companies.  And they charge you according to a percentage of the value of your home, which means the more your house is worth, the more they will want, and the more you will have to pay each year.

 

Now I know that the government (either city, county or state) will want you to pay some sort of tax on the land/property you own.  As for the insurance, I believe this is usually just a requirement of the financial institution for you to have.  This is in case something happens to your home: they want their collateral taken care of.  For that reason, I'm not sure there are any financial institutions out there that would allow you to have a home loan without insurance.  Same reason they require it if you get a car loan. 

 

The tax is usually paid to the county.  There are two ways to generally pay it: yourself when the taxes are due (usually once or twice per year, depending on where you live) or through an escrow account.

 

There are three types of insurance that the mortgage holder would or could require you to have: hazard insurance, flood insurance, and mortgage insurance.

 

Hazard insurance is to prevent, you might guess, hazards.  It can cover everything from natural disasters to man-made disasters.  It doesn't cover floods, however, and that is why your mortgage holder would require you have flood insurance if your property is found to be in a flood zone.  Mortgage insurance is (or rather "should be") only required if you have less than 20% invested in your house.  You might see or hear some refer to an 80% mark, but that refers to 80% loan to value (LTV).  "20% vested" and "80% LTV" refer to the same thing, it just depends on whether you think of it as "I need to borrow 80%" or "I have invested 20%."  I prefer to think of the "invested" side :)

 

For example, let's say you're looking to purchase a house for $100,000.  In order to avoid mortgage insurance (also referred to as "private mortgage insurance") you must invest at least $20,000.  Or, on the flip side, borrow no more than $80,000.  If you put just $19,999 down on the purchase of the house, you will have to pay mortgage insurance on it.  And removing it is not always easy.  So, if at all possible, have 20% to invest in your house.  Most people, unfortunately, cannot put down 20% (or do not want to wait until they've saved that much).  Often times, a second mortgage that closes at the same time as the first is requested.  This goes by multiple names: PM2 (Purchase Money 2nd), 80/10/10, 80/15/5.  Mortgage insurance, just like insurance in general and like paying interest to a bank, is lost once it is paid.

 

 

The last thing that many people are surprised by when purchasing a home is their closing costs.  These are not to be confused with origination fees.  The difference is kind of like a "Honda" versus a "car."  All Hondas are cars, but not all cars are Hondas.  Similarly, Origination fees are part of the closing costs, but they are not, in and of themselves, all of the closing costs.  When people mention charging "points" for a home loan, they are referring to origination fees.  Points, plain and simple, are a percentage of your loan amount.  One point = one percent.  So, if you are borrowing $100,000 and paying one point, you will pay an additional $1,000 in fees.  And what does paying an extra $1,000 do for you as the borrower?  Well, it should get you a lower rate on your mortgage than you should have otherwise received had you not paid it.  For instance, instead of getting a 6.50% loan, you pay $1,000 up front and get a loan at 6.00%.  Is paying the extra $1,000 worth it?  Generally yes, but make sure you calculate it and find out for sure if it is worth it.  One way to consider whether it is worth it is to find out the "breaking point" between the fee paid and the interest saved.  For example, the $1,000 you spent extra may take 5 years to recoup before you've broken even (i.e. spent $1,000 in interest through the 6.5% rate).  What this "5 years" figure gives you is an idea of how long you have to pay on your mortgage before it's worth it.  In other words, if you sell/pay off your house within 5 years, it's not worth it.  If you keep the house for more than 5 years, it is worth it.

 

Here is another amortization table with a breakdown of the first/last years payments on a $100,000 mortgage, 30 years, at 6.00%.

 

Pmt	Principal	Interest	Cum Prin	Cum Int	Prin Bal
1	99.55	500.00	99.55	500.00	99900.45
2	100.05	499.50	199.60	999.50	99800.40
3	100.55	499.00	300.15	1498.50	99699.85
4	101.05	498.50	401.20	1997.00	99598.80
5	101.56	497.99	502.76	2494.99	99497.24
6	102.06	497.49	604.82	2992.48	99395.18
7	102.57	496.98	707.39	3489.46	99292.61
8	103.09	496.46	810.48	3985.92	99189.52
9	103.60	495.95	914.08	4481.87	99085.92
10	104.12	495.43	1018.20	4977.30	98981.80
11	104.64	494.91	1122.84	5472.21	98877.16
12	105.16	494.39	1228.00	5966.60	98772.00

 

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349	564.72	34.83	93598.17	115644.78	6401.83
350	567.54	32.01	94165.71	115676.79	5834.29
351	570.38	29.17	94736.09	115705.96	5263.91
352	573.23	26.32	95309.32	115732.28	4690.68
353	576.10	23.45	95885.42	115755.73	4114.58
354	578.98	20.57	96464.40	115776.30	3535.60
355	581.87	17.68	97046.27	115793.98	2953.73
356	584.78	14.77	97631.05	115808.75	2368.95
357	587.71	11.84	98218.76	115820.59	1781.24
358	590.64	8.91	98809.40	115829.50	1190.60
359	593.60	5.95	99403.00	115835.45	597.00
360	597.00	2.99	100000.00	115838.44	0.00

 

The payments, you will notice, are smaller at 6.00% than they were when the interest was listed at 6.50%.  Instead of paying $632.07, the payment is only $599.55.  Also, if you notice the 2nd column from the right (Cumulative Interest) shows how much interest the borrower pays over the 30 year period.  If you remember, for the first example (at 6.50%) the cumulative interest was $127,542.48; in this example (at 6.00%) it is $115,838.44.  This is a difference of $11,704.04.  Which means, if you pay $1,000 today, you will end up saving $10,704.04 over the next 30 years (the difference between how much you pay today, $1,000, and how much you save with the lower rate, $11,704.04).

 

So one of the closing costs would be origination fees.  But, what else do we have to pay for in closing costs, you ask?  Well, it's the cost of getting the loan, basically.  This includes everything from drawing up the loan papers to verifying the property (yeah, believe it or not, the bank wants to make sure the property exists)...even the funding of the loan can have costs associated with it.  Now, it is possible to get a home loan without closing costs, but it will most likely mean a higher interest rate.  Just like paying more today in origination fees should mean a lower rate, asking for fewer closing costs usually means a higher rate.  And, remember, higher interest rates means you might save money today, but you will end up paying a lot more in the long run.

 

If you've shopped around different places for the best rate and a financial institution has the best rate you've found and claims there are no closing costs...first read all the fine print...then sign up! 

 

For example: the latest commercial I've witnessed from Quicken Loans.  Over and over in the commercial they mentioned how they could refinance a $1049/month loan for as little as $703/month.  They talk over and over about how much money you'll save every month and how great of an interest rate you'll get.  The problem is, they don't mention the truth of it all:  the monthly payment they give you is either an interest only loan or a negatively amortizing loan.

 

What does that mean to the average consumer? 

 

Anytime you see an offer for credit with what appears to be a really good monthly cost, do this quick calculation for me:

 

Total loan amount X interest rate / 12

 

This will give you how much just the interest (i.e. cost of getting a loan) will actually cost you.  Keep in mind, this is NOT (or at least better not be) the actually monthly cost of the loan.  In order to calculate this, of course, we will need to know exactly how many months you want to take to pay off the loan.

 

This equation gives you an approximate monthly interest:  technically the amount of interest you pay per month will depend on many things such as the daily interest charge (the equation above divided by 365 instead of 12) as well as the time passed since the last payment was made.  But let's take this equation and go with it:

 

The example listed above from Quicken Loans is on a $150,000 home loan at 7.5% (which, as of this writing in August of 2006 is nearly 1% above market average).  If we amortize the payment of $150,000 at 7.5% over 30 years, you will notice that Quicken is right, your payment would be $1048.82 (they rounded up toe $1049).  But how much of that is interest?

 

Well let's take $150,000 X .075 / 12.  We will get...

 

...drum roll please...

 

$937.50!

 

That's right: Quicken only charges you $703 on a loan whose interest rate will charge over $900 per month!  This means that every month you will be increasing rather than decreasing the amount you owe the bank (can't forget that pesky $150,000 ya borrowed, right?)