- A Home owner's Mortgage is a long term loan in which the property is pledged s the security for payment of the difference between the down payment and the sales price.
- Generally for a large amount of money.
- There are several types of Mortgages
- A conventional loan, or fixed installment loan
- An adjustable rate mortgage (ARM), where the interest rate will change depending on current economic factors
- We will deal with conventional loans.
- Frequently banks charge points when issuing a loan
- A point is 1% of the amount financed.
- Sometimes a point will reduce the interest rate.
- But sometimes it is just a finance charge.
- The IRS calls points prepaid interest
- Because points, and other finance charges are part of the loan, you will usually be quoted two interest rates
- The first is the rate of interest charged
- The second includes all finance charges, called the APR
- Sunday (2/1/15 ) on line rates from Marquette Bank.
- Example: Bob wishes to purchase a $150,000 home. The bank requires 20% down and is charging 1.5 points. What is the down payment, amount financed and the cost of points?
Down Payment: 150,000 x .2 = $30,000
Amount Financed: 150,000 - 30,000 = $120,000
Points: 0.015 x 120,000 = $1,800
- The banks want to make sure that you can afford your house so
- They will want to see where the down payment and points come from.
- They will also want to compute your adjusted monthly income
- Compute the adjusted monthly income
- Start with the gross monthly income
- Subtract any payments with more than 10 months.
- Car payments.
- Student loan payments.
- Child care payments or other regular payments.
- Credit cards are considered here as well, especially those with a balance.
- But not taxes, rent (you will have a house!), utilities.
- The bank will not let you have monthly payments more than 28% of your adjusted monthly income.
- Example: Bob has a salary of $56,000 a year. He has a monthly student loan payment of $400 and a car payment of $250 each month. Both loans have more than ten months remaining. Bob's bank will only allow a monthly mortgage payment, including taxes and home owners insurance of 28% of his adjusted monthly income. What is the maximum payment Bob will be permitted to make?
Compute gross monthly salary
56,000/12 = $4,666.67
Subtract regular payments
4666.66 - (400+250) = $4,016.67
Determine 28% of Bob's adjusted monthly income
4,016.67 x 0.028 = $1,124.67
- Next we need to compute the monthly payment.
- We can do this two ways, with the formula m=p(r/n)/(1-(1+r/n)^(-nt))
- Or with a table.
- Compute Bob's Monthly Payment
Bob wanted to finance $120,000 for 30 years at 4.5% interest
Look up 4.5% for 30 years on the table: 5.06685
Bob wants to borrow 120,000/1000 = 120 $1000
So Bob's total monthly payment would be
120 x 5.06685 = $608.02
Or
120000x0.05/12/(1-(1+.05/12)^(-12*30)) = 608.02
- Qualifying for a loan
- You must make the monthly loan payment.
- Plus you must pay 1/12 of all taxes each month.
- Plus you must pay 1/12 of all homeowners insurance each month.
- And the sum of these three must be less than the 28% of your adjusted monthly income.
- Does Bob qualify for the loan?
Bob's taxes are estimated at $2400 per year.
1/12 of Bob's taxes are 2400/12 = 200
Bob's homeowners insurance will be $800 per year
1/12 of Bob's insurance is 800/12 = 66.67
So Bob's total commitment to his house is
608.02 + 200 + 66.67 = $874.69
Which is below the $1,124 he is allow, so he qualifies for the loan.
- Paying for the House
- House payments, like the credit card payments we saw last time pay the interest first then a portion of the principal.
- We once again treat this like a simple interest loan.
- How much of Bob's first payment is applied to the principal and how much will he owe after his first payment.
In the fist month, Bob has 120,000 for 1/12 of a year at an interest rate of 4.5%
i = prt
i = 120,000 x 1/12 x 0.045 = 450
Bob sends in a payment of $874.69
But remember $200.00 of that pays for taxes
and $66.67 pays for insurance
and $450.00 is interest
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So $716.67 goes to expenses other than principal
874.69-716.67 = 158.02 goes toward principal
Bob owes 120,000 - 158.02 = $119,841.98
- Look at this workbook
- How much does Bob pay for his house?
Compute the total of all payments
608.02 * 30 * 12 = 218,887.20
Add in the $30,000 down payment and the 1.5 points
218,887 + 30,000 + 1,800 = $250,687
How much interest did Bob pay?
218,887-120,000 = $99,887
- However, please note
- Bob now has a house, which probably appreciated in value over 30 years
- He did not have to pay rent
- And mortgage interest on your primary residence is tax deductible.
- But he did have to pay to fix things.
