My wife and I bought our house 7 years ago. We signed up for a 30-year mortgage at a reasonable interest rate and with manageable monthly payments. Despite all the research we did and counsel we had, I can say now, looking back on all I’ve learned since then, I really did not understand what I was getting myself into. In this post I want to walk you through some of the details that come with the purchase of a home and hopefully it will open your eyes to the real costs of buying a house so you can make a more informed decision when the time comes.
What is a home mortgage?
A home mortgage is a loan that financial institutions provide for a house that the loanee, the individual or couple taking out the loan, is required by contract to pay off in a designated period of time with a predetermined interest rate.
Many people think that when they purchase a home, they are simple required to pay the exact amount of money the house sold for. That is very, very far from the truth.
Here is a scenario to help us think through the costs of buying a home and hopefully making it more understandable so we all can be more realistic in our expectations when taking this major financial step. This scenario is not using the numbers of what my wife and I bought our house for. Rather I wanted to use easy numbers to make the illustration less complex.
I want to buy a house that is selling for $110,000. If I have $10,000 in cash that I could use toward the purchase of the house, I still need a loan for the remaining $100,000.
I can go to my local bank or credit union and ask for a loan for the $100,000. They would have to check my credit score and amount of annual income to make sure that I was able to pay them back. If they think I am able to, they will give me the loan for the period of time I want to pay the loan off in with an interest rate based on the rates available during that time
Let’s say I went with a 30-year mortgage. If I had zero interest rate, which will never happen, my monthly payment would be $277.78 a month. Pretty reasonable right? If we were to multiply that out for the length of my loan, I would pay $100,000.80 total over the next 30 years. That sounds completely fair because that’s what I bought the house for. However, it is not that simple. There are multiple more layers to consider for additional costs. The first one is interest rate.
Once we add in an interest rate my monthly payment amount changes. Let’s say I have a 3% interest rate which is a low interest rate. My new monthly payment would raise from $277 all the way to $421! Why is that? I am not paying 3% of the $277 a month, but rather I am paying 3% of the loan amount which is $100,000. Another thing that I need to know is that as I pay off my loan, and I owe less to the bank or mortgage company, my interest rate does not drop with the new balance. So, even in 20 years when I have paid off most of my loan, I am still paying 3% of $100,000 in interest every single month.
To add another layer of frustration, there are extra charges each month to make that new payment of $421 even higher. In addition to the base payment and interest on that payment, I will also have to pay property taxes, and home insurance.
Depending on where you live, both of these numbers are going to be drastically different. If you live by water, your home insurance will cost more because of the potential of flooding. Your property taxes will also probably cost more. If you have more land your cost will go up. Depending on the city you live in, your cost could be higher than the city a few streets down.
For the sake of the illustration, let’s put in some numbers though that are very basic. Assuming your house is not at high risk for any issues, and your city is extremely affordable, you have to pay $80 a month for property taxes and $80 a month for home owner’s insurance. Adding those two numbers to the $421 from before, we now have a total monthly payment of $581. A whole other layer of confusion to keep in mind is that your property taxes will continue to raise every year. For sake of this scenario, I am not going to include that, but I wanted to make that note.
So just for a quick summary before we continue: rather than paying $277 a month for my loan, I am now paying $581. That in an increase of $304 dollars a month from what I originally thought I would be paying when I purchased the home. If I multiply the new monthly total of $581 a month out for 30 years my total is $209,160 for my $110,000 home!
That is a huge increase! Below I have a quick chart to compare some different scenarios and hopefully make this very complex scenario a little more manageable to understand.
Purchase Amount 110,000 110,000 110,000 110,000
Down Payment 10,000 10,000 0 0
Interest Rate 3% 3% 3% 3%
Mortgage Length 15 years 30 years 15 years 30 years
Home insurance $80 a month $80 a month $80 a month $80 a month
Property Taxes $80 a month $80 a month $80 a month $80 a month
Monthly Payment $850 $581 $919 $623
Total Paid $150,000 $209,160 $165,420 $224,280
Extra Paid $40,000 $99,160 $55,420 $114,280

As you can see by the above chart, the only things changed were the total length of the loan of either 15 years or 30 years and the down payment of either $10,000 or $0. The important thing to note, however, is that each of these scenarios has you paying significantly more than the original loan amount. I think too many people when looking at purchasing a home do not understand how much they are actually going to pay over the life of the loan. I know that I didn’t when I bought my house.
There is a lot more information to discuss with mortgages though. This brief post really only just scratched the surface of the mortgage discussion. I am going to write a number of different posts addressing many different questions. Here is a list of some of them:
• What are the different types of home mortgages?
• What is a down payment and how much should that be?
• How are interest rates determined?
• What is the difference between the principle and the interest and do those numbers change?
• How important is my credit score when getting a home loan?
• What is PMI?
• What are points and should I want them?
• What is the difference between an interest rate and an annual percentage rate?
• What are closing costs?
• Do I qualify for down payment assistance programs?
• How does having a Roth IRA benefit me on the purchase of a first home?
• Who can I get a home mortgage through?
• What is refinancing and what are the pros and cons of it as well as the hidden costs?