You can leverage your real estate investments by borrowing money to afford a higher purchase price. Knowing how to calculate a mortgage payment is important to make significant business decisions when adding to your real estate portfolio.
Typical Costs Included in Your Mortgage Payment
Your mortgage payment involves many costs, not just the amount you borrow to invest in a home. Some variables you may control, but others are fixed monthly expenses you must include in your mortgage payment, such as monthly interest, taxes, and insurance.
The mortgage principal is the loan amount you borrow to buy a home. To determine the loan’s principal, first determine the size of the down payment you’ll make on the property.
For example, if you’re considering a property that costs $300,000 and has a $100,000 down payment, your loan principal would be $200,000, as that’s how much you need from the bank to complete the transaction.
Interest is the fee you pay to borrow the money. You pay an annual interest rate but make monthly payments with a monthly interest rate (the annual rate divided by 12). The interest rate on investment properties is usually slightly higher than the rate lenders give borrowers purchasing a primary residence because there is a higher risk of default on investment properties.
Your initial mortgage payments will be more interest than principal, but as you pay the principal balance down, the interest paid in each payment decreases. You can evaluate interest savings by shopping around for the best loan program.
Property taxes are a significant part of your mortgage payment, as they are required to own a home. Since you are the property owner, you are responsible for paying the property taxes. You may set up an escrow account and include one-twelfth of the annual tax bill in your mortgage payment or pay the property taxes yourself, but you should still consider them a part of your mortgage payment to keep up with the property tax bill.
Conventional loan lenders must charge private mortgage insurance (PMI) when borrowers put down less than 20% on a property. This insurance protects lenders if a borrower doesn’t make the required payments and is an added layer of reassurance when lending to an investor with a loan amount that exceeds 80% of the property value. To avoid mortgage insurance, you must put down at least 20% on the property, which most investment loan programs require.
All lenders require property owners to carry homeowners insurance to protect against any losses on the home. Most lenders require 100% of the replacement cost in coverage to ensure enough financial protection to rebuild the house should there be a total loss, such as a fire.
HOA (homeowners association) fees
You’ll be responsible for the fees if the property is in a homeowners association. Most lenders don’t include the HOA fees in the mortgage payment, but it’s a part of your monthly expenses and should be included so you know your total monthly costs and can determine if a property makes financial sense.
What Is Amortization, and How Does It Impact Your Payment?
Mortgage amortization refers to how you repay the mortgage loan. Mortgage loans have a fixed monthly payment and defined end date. Although the payment amount is fixed, the amount you pay toward the mortgage principal and interest changes monthly, even if the monthly rate doesn’t change.
For example, if you borrow $200,000 over 30 years at 6%, your monthly mortgage payments would be $1,199.10. In the first month, you’d pay $199.10 toward principal and $1,000 in interest. By the 12th month, you’d pay $210.33 in principal and $988.77 in interest.
By the last payment, you’d pay $1,193.44 in principal and just $5.97 in interest. As you can see, paying interest is a part of the mortgage formula, but the amount you pay decreases over time.
How to Calculate Your Monthly Mortgage Payment
Knowing how to calculate your mortgage payment is important, but if you prefer that the calculations are done for you, there is an easy mortgage calculator.
An easy formula
To calculate your monthly mortgage payments, you’ll need the following information:
- (M) Monthly payment amount
- (P) Principal amount or the loan balance
- (I) Annual interest rate divided by 12 months
- (N) Number of payments
The mortgage formula is calculated as follows:
M = P [ I(1 + I)^N ] / [ (1 + I)^N ? 1]
As you can see, using a mortgage calculator provides the easiest way to calculate your monthly payments, especially as you look at different financing options when buying an investment property. The key is finding financing you can afford that makes sense in your operational costs.
What Are the Different Types of Mortgages?
As a property investor, you have several options when choosing the loan type. Government-issued mortgages usually aren’t an option except in rare circumstances, but the remaining loan types can help.
Conventional mortgage loan
A conventional mortgage loan isn’t government-backed. They are available as conforming and nonconforming loans.
Conforming loans follow the FHFA guidelines, including loan size, credit score, and debt-to-income ratios. The current conforming loan limits are $726,200 and $1,089,300 in high-cost areas.
Nonconforming loans don’t follow the FHFA guidelines and provide more customized options for investors with unique credit profiles or buying expensive properties.
Jumbo loans are a subset of the nonconforming loan category. These loan amounts are higher than the conforming loan limit and are more common in high-cost areas.
A fixed-rate mortgage is the easiest to use when learning how to calculate a mortgage payment. With a fixed interest rate, your monthly payments never change. The only exception is if you have an escrow account and your property taxes or homeowners insurance bills increase or decrease. Most fixed-rate mortgages are available in 15- to 30-year terms.
An adjustable-rate mortgage is a little harder to perform a mortgage calculation on because the interest rate changes. This is when mortgage calculators are most useful because you can calculate best- and worst-case scenarios when deciding if an ARM mortgage fits your budget.
Government-insured mortgages are for primary residences only and include FHA, VA, and USDA loans. The only way a property investor could use government-insured mortgage programs is by house hacking, or buying a multiunit property, living in one unit as their primary residence, and renting out the remaining units.
Government-insured mortgages often have lower interest rates, but some loans, like FHA, charge mortgage insurance for the life of the loan balance.
A reverse mortgage is for homeowners in their retirement years who want to use their home equity but not leave the home. A reverse mortgage doesn’t require a monthly mortgage payment but accrues interest that becomes due when the borrower no longer lives in the home.
15-year mortgages vs. 30-year mortgages
As you calculate your monthly mortgage payment, you can choose a 15- or 30-year mortgage. The longer 30-year term has lower monthly payments, but you’ll pay more interest over the loan term. A 15-year term has a higher monthly payment, but you pay the loan off faster, paying less in interest.
Mortgage Interest Rates
Mortgage interest rates have been a hot topic since the pandemic. During the shutdown, interest rates were lower than anyone had seen in decades, but they have since increased, which to some seem high, but they are back at their typical level.
When deciding if you should invest in a property, the mortgage interest rate is important in the mortgage formula. It’s not the only factor you should consider, but it is a cost of investing and can reduce your profits, so it’s a good idea to shop around and get the lowest interest rate you can.
What Is a Debt-to-Income Ratio?
When lenders determine if you’re approved for a mortgage loan, they assess your credit score, income, and debt-to-income ratio.
The DTI measures your gross monthly income to your monthly debt payments. The ideal DTI is 36%, but many lenders allow property investors to go higher, especially if you are a seasoned investor.
How does a debt-to-income ratio affect affordability?
However, your DTI affects your affordability. If the industry struggles, the more money you have committed to monthly obligations, the harder it becomes to afford your payments. For example, if you max out your affordability and suddenly have an increased vacancy rate, you might struggle to make ends meet. Keeping your DTI at a manageable level is ideal.
How a Larger Down Payment Affects Your Payment
When investing in a property, you will likely make a down payment. The more money you put down, the easier it is to get approved for financing, and it lowers your monthly payment. In addition, some lenders may offer a lower interest rate if you have more equity in the property.
Tips for Managing Your Mortgage Payments Throughout the Life of Your Loan
After using a mortgage formula or calculator to determine your mortgage payment and getting approved, it’s important to know how to manage your mortgage payments, especially if you own multiple properties. Here are some tips:
- Set a budget: Make sure your monthly mortgage payment fits into your budget and that you account for the area’s average vacancy rates, so you have a better idea of how much income you’ll receive.
- Keep an emergency fund: As a landlord, you’re responsible for all repairs and regular maintenance on the property. Having the money handy will avoid issues affording your monthly payment.
- Make extra payments: If you have the money, consider making extra payments to shorten your loan term and save money on interest costs.
Mortgage Payment FAQs
Knowing how to calculate a mortgage payment is important. Here are a couple of common questions investors have about mortgages.
Why does your mortgage periodically go up?
If you have a fixed monthly payment, you might wonder why it changed. You have a fixed interest rate, so your mortgage principal payment or interest rate didn’t change, but your property tax or homeowners insurance bill might have increased. Your mortgage company will conduct an escrow analysis annually to determine if your mortgage payment is enough to cover your annual costs, or if it must change.
How do lenders decide what you can borrow?
Lenders look at many factors when deciding how much house you can purchase. They examine your credit score, history, income, employment, and assets. They calculate your debt-to-income ratio and compare your intended down payment to the minimum down payments required for each loan program. Lenders must ensure you can afford the payments beyond a reasonable doubt.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.