SO WHAT IS THIS GOING TO COST YOU?
So you have the itch to buy a new home, as you know, at Go Team Realty, we never want to sugar coat things just to sell a house. So we decided we should take a minute to explain to you the true costs of homeownership. There can be a lot of unforeseen costs that you would not know to expect if you are currently renting. Let’s break down the key areas that are the most significant so that you know exactly what you should expect once you have signed on the dotted line.
Your mortgage payment is going to be made up of four different costs, unless you finance more than 80% of the value of your home, then there are five (we will discuss this in a minute). These charges are mostly dynamic, meaning that they change, or at least can change every year. Your mortgage will be made up of your principal, loan interest, property taxes, and homeowner’s insurance (PITI as it is known in the industry). If you have financed more than 80%, you will also be responsible for private mortgage insurance (PMI), thanks to those crafty folks that were responsible for the market collapse in 2008. It is extremely important to understand that when banks give you an estimated monthly payment, you may find that they only include a portion of these items. Some may only give you the cost of the principal and the interest, which can be very misleading.
Principal
The principal, in theory, is the amount of money that you borrow divided by the amount of payments you agree to. A traditional 30 year mortgage will be broken down into 360 payments. So if you borrowed $200,000 to buy a house, you would owe $555.55 every month for the next 360 months. There are also 15 and 20 year mortgages that would lower the number of payments, but raise the monthly costs. Since there are 180 months in 15 years, your payment would essentially double monthly at $1,111.11. So you definitely want to explore your options in order to figure out which scenario helps you meet your goals.
Interest
Because banks do not lend money out for free, you will also be responsible for the interest you are charged to borrow their money. The interest rate you agree to is important because over 30 years a couple of points could wind up costing you thousands and thousands of extra dollars. Here is also where it can get a bit confusing, the banks like to front load their interest so that you are paying interest at a higher rate than the principal, earlier in the loan. This could be the reason that banks will give you an estimated monthly cost that includes principal and interest only, because the total of these two numbers usually stays constant, even though your monthly payment is allocated differently.
We know, that was a lot of info in a few words, so feel free to request an example amortization chart to help you wrap your mind around it. Here is a good example, if your estimated principal and interest payment will be $954.83 monthly, your first payment will allocate $666.67 towards interest, whereas on your last payment only $178.01 goes towards interest. As your interest payment decreases over the life of your loan, the money applied to the principal increases accordingly. Also, you will want to note that over a 30 year mortgage at a 4% interest rate, you will pay close to $145,000 in interest alone.
Property Tax
Property taxes are local taxes that provide the largest source of funding that local governments use to pay for schools, streets, roads, police, fire protection and many other services. As such, property tax is the third constant on your mortgage payment. The tax rate is set by the county in which you live. Usually, your bank will establish an escrow account, tied to your home mortgage, in which they will collect your annual expected tax load over the course of your 12 monthly payments that year. At the end of the year, you will receive a tax document showing how much property tax was payed on your behalf.
This number is dynamic because every year the county will re-assess the value of your property and multiply that by the tax rate your county has selected to determine how much you owe. This can be a problem for homeowners because if you live in a developing area, the values of your property will probably be on the rise which would be compounded by the areas growing need for county services. You will want to analyze these numbers every year, if you feel like your taxes are being raised disproportionately, you can contest your value with your county (but we will re-visit that topic another day). You can also homestead your property to limit the amount that they can raise your values from year to year.
Homeowner’s Insurance
The last part of your mortgage payment is the cost of your homeowner’s insurance. To get a home loan, you will have to provide proof of insurance to the lender before you close. It is in your lender’s best interest to make sure you have insured the property that they are loaning you money on. So, your lender will usually collect this money for you and put it in an escrow account for the year, very similarly to how they collect for your property taxes. This number is dynamic as well because homeowner’s insurance can change from year to year. Be sure you select a company and a policy that you are comfortable with. Shopping around can help you save money here.
Mortgage Insurance
Mortgage Insurance is a premium that applies to people that finance more than 80% of their home loan. So if you purchase our example home at $200,000 and are not prepared to put $40,000 down up front, you will be responsible for paying a premium for the life of the loan. This number is payed yearly and can be anywhere from 0.5%-1% of the entire loan. Assuming the rate is 1% and your loan is $200,000, your payment would be $166.67 per month or $2,000 per year. That could be as much as an extra $60,000 over the life of your loan.
Utilities
If you have been renting for any length of time you may be in a situation where your rent includes certain utilities. When you are a home owner, your utilities will vary, but you will be responsible for paying these utility companies for all services provided. For example, a typical home will require the following utilities: electricity, water, city trash, sewage and propane. Depending on your location, your utilities could all be provided by one large provider or several different providers. You will want to gain a good understanding of what the total costs can be before you purchase so that you can budget accordingly. These charges are also dynamic and change based on demand or usage.
Upkeep
Lastly, you will be responsible for the upkeep and improvements to your property. You should now have a better idea of how serious of an investment homeownership can be. You will want to take care of your asset by properly maintaining the condition. When you were renting and the AC went out, it was the owner’s problem. In this situation, you are the owner. Keep in mind that you will be buying products to clean your property on a regular basis, consumables like AC filters and light bulbs are often over looked, as well. When you purchase your home, it may come with all of the appliances you need, or not, it may be brand new, or it might need major repairs. All of these costs add up so you will want to have a healthy expectation of the changes in responsibility when you move from renter to owner.
Homeownership can be a very rewarding experience and comes with many benefits. But make no mistake, this is a serious investment. There are many ways to protect yourself when it comes to your money and your home. There are also many ways to help curtail some of the largest costs. For example, making one extra payment per year, can help you pay off your 30 year mortgage 6-7 years early and save thousands and thousands of dollars in interest. If, you are on the verge of buying, it is important to avoid the pitfalls that people experience due to a lack of knowledge.