How does a home loan calculator work?
Mortgage calculators are online tools that estimate your monthly mortgage payment and terms, offering personalized loan recommendations, including:
- Monthly payment breakdown (principal, interest, taxes, insurance, HOA fees and PMI)
- Loan term (in years)
- Fixed or adjustable interest rate options
- Interest rate and annual percentage rate (APR)
- Estimated closing costs (attorney fees, lender charges, title insurance, etc.)
To use a mortgage calculator, provide essential details like:
- Home price
- Down payment amount or percentage
- Property type and location
- Monthly expenses (taxes, insurance, HOA fees, etc.)
- Credit score
Monthly mortgage payment components
The interest rate significantly affects your monthly payment. In the early stages of a mortgage, a substantial portion covers interest. Focus on the base rate, not the annual percentage rate (APR), as it excludes closing costs. While APR considers the loan's overall cost, it doesn't directly impact monthly payments.
Frequently asked questions
Your monthly mortgage payment can be calculated using the following formula: M = P [ I(1 + I)^N ] / [ (1 + I)^N - 1]
Here's a breakdown of the variables within the formula to help you understand it better:
- M = monthly payment: This is the value you want to find.
- P = principal amount: It represents your loan balance, which is the amount you're aiming to pay off.
- I = interest rate: Be sure to use the base interest rate, not the APR. To get the monthly interest rate, divide the annual rate by 12.
- N = number of payments: This is the total count of payments throughout your loan term. For example, in a 30-year mortgage with monthly payments, there would be 360 payments in total.
It's worth noting that mortgage calculators typically assume fixed-rate mortgages. However, if you have an adjustable-rate mortgage (ARM) with changing interest rates over time, you can set up an amortization table using spreadsheet software like Microsoft Excel. This allows you to adjust the formula when the interest rate changes, ensuring your calculations remain accurate.
To calculate the principal of your mortgage, you start by deducting your down payment from the total purchase price of your home.
Let's illustrate this with an example: If you're purchasing a house for $450,000 and you make a 20% down payment, which amounts to $90,000, your remaining loan amount is $360,000. This $360,000 is your principal balance.
Understanding the principal is crucial when determining your home affordability because it's the base amount you borrow, and interest begins accumulating as soon as you secure the loan. To get an estimate of your monthly mortgage payment within your budget, you can use our mortgage calculator. By entering details like the purchase price, down payment, and other relevant factors, the calculator provides you with a rough monthly payment estimate. Remember that when setting a comfortable mortgage payment, you should also consider other expenses such as maintenance, insurance, taxes and repairs associated with homeownership.
Continuing with our example, suppose you have a 30-year mortgage with an annual interest rate of 7%. Because you're making monthly payments, the 7% annual interest rate is divided by 12 to calculate the monthly interest. In this case, your initial monthly payment would consist of $2,625 in interest, which is computed as follows: ($450,000 principal × 0.07 annual interest rate) ÷ 12 months.
To break it down further: The principal is determined as the purchase price minus the down payment. The monthly interest is computed by taking the principal and multiplying it by the interest rate, then dividing it by 12 months. The monthly principal can be found by subtracting the interest payment from the total monthly mortgage payment. In summary, the initial monthly payment on your mortgage is divided between the interest and principal components, with the interest being a portion of the outstanding loan balance, while the principal is the remainder.
On a $300,000, 30-year mortgage with an 8% APR, you can expect a monthly payment of about $2,201.29, not including taxes and interest (these vary by location and property).
On a $400,000, 30-year mortgage with an 8% APR, you can expect a monthly payment of about $2,935.06, not including taxes and interest (these vary by location and property).
Prospective homebuyers' ability to afford a property and the size of the loan they can secure largely depend on various factors, but the main considerations include their income, debt, assets and liabilities.
- Gross income: This is your total income before taxes and other financial commitments. It encompasses your base salary, any additional income like bonuses, part-time earnings and self-employment income, as well as benefits such as Social Security, disability, alimony and child support.
- Front-end ratio: This ratio, also known as the mortgage-to-income ratio, is determined by your gross income and represents the percentage of your annual gross income that can be allocated to your monthly mortgage payment. The monthly mortgage payment includes principal, interest, taxes and insurance (PITI). A general guideline is that the front-end ratio, based on PITI, should not exceed 28% of your gross income. However, some lenders allow borrowers to surpass 30% or even 40%.
- Back-end ratio: The back-end ratio, or debt-to-income ratio (DTI), calculates the portion of your gross income needed to cover your debts, including credit card payments, child support and other outstanding loans (such as auto or student loans). For example, if you pay $2,000 in debt services each month and earn $4,000 monthly, your ratio is 50%—half your income goes toward debt. Most lenders recommend that your DTI does not exceed 43% of your gross income.
- Credit score: Mortgage lenders evaluate your credit score to assess the risk of lending to you. A low credit score may result in a higher interest rate (APR) on your loan. To secure a home, monitor your credit reports and address any inaccuracies promptly.
- The 28%/36% rule: This heuristic helps calculate the appropriate amount of housing debt to assume. According to this rule, a maximum of 28% of your gross monthly income should cover housing expenses, and no more than 36% should go toward total debt service, which includes housing and other debts like car loans and credit cards. Lenders use this rule to gauge whether to extend credit to borrowers and sometimes it is adjusted to use slightly different percentages, such as 29%/41%.
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How to get pre-approved for a mortgage
You’ve found the perfect house and are feeling like you’re ready to buy, but will you qualify for a mortgage?
If you’re currently making your way through the homebuying process, you know how much is riding on qualifying for a loan. This makes early preparation the best way to increase your chances of approval, and that starts with getting pre-approved for a home loan. But what does pre-approval even mean? What is the difference between that and pre-qualification or loan approval?
Read on to better understand what it takes to get pre-approval for a mortgage.
How pre-qualification differs from pre-approval for a mortgage
When you’re looking to buy a new home, you’ll find lots of self-help checklists and guides to walk you through the process. Many mention going through a pre-qualification process to get feedback from a lender before you start getting serious about buying a new home.
There’s a difference between pre-qualification and pre-approval for a mortgage.
Pre-qualification takes place at an early stage. It’s an estimate of what you might be able to borrow based on the information you provide about your financial status. Different lenders pre-qualify in different ways, but in general, a lender will look at:
Your credit score: Lenders perform a soft check on your credit, reviewing your credit history without the check appearing on your credit report. This will give them an overview of your history to help them determine your creditworthiness.
Your debt-to-income ratio: This percentage is calculated by dividing your total monthly debt payments by your gross monthly income. This is used as a gauge to determine if you’ll be able to stay on track with your monthly expenses.
Down payment: This is the dollar amount you’ll put toward the purchase price when you close. Anything below 20 percent will require private mortgage insurance (PMI), which will increase the size of your monthly payment. It may also affect which loans you qualify for.
Pre-approval takes it a step further. Instead of performing a soft credit check, the lender will go through the entire verification process, and you’ll need to provide the documentation to confirm your status. If you’re pre-approved, you’ll be provided with a pre-approval letter that you can submit to your real estate agent and sellers as added assurance that you’re able to purchase the home. This pre-approval is usually valid for up to 90 days.
How far in advance should you get pre-approved for a mortgage?
Thinking of buying a new home? It’s time to start the pre-approval process. Lenders will tell you it’s never too early to apply. Ideally, anywhere from six months to a year before you plan on buying a new home will give you plenty of time to make corrections.
Checking your credit score will alert you to potential problems. It’ll give you a chance to clear up any issues that might prevent you from getting a home loan or that could hold you back from better terms.
Think of the pre-approval process as a financial check to ensure you qualify for a home loan. Inquiries won’t have a lasting impact on your credit score unless you take out a loan.
Are you ready to move forward with the pre-approval process?
When you’re ready to move forward with the pre-approval process, you’ll be required to complete an application and provide important documentation. This includes:
Proof of income: You must provide W-2 wage statements and two years of tax returns. You should also submit current pay stubs that show your total year-to-date income. If you have any other income sources, such as alimony or bonuses, offer proof at this time.
Proof of assets: If you’ll be using a bank or investment account to finalize the down payment or closing costs, provide evidence of these accounts.
Credit score: Most lenders require a FICO score of 620 to qualify for a conventional loan. If your score is lower, there may be other programs that you qualify for. For example, FHA loans typically require a score of 580. Lenders will usually offer lower interest rates to customers with better credit scores. If you start this process early, you can work on improving your score to take advantage of better terms and interest rates.
Employment verification: Lenders want proof that you are currently working and have stable employment from the past and into the future. Most lenders will call your employer to confirm employment and salary. If you’re self-employed, the process is a little more complicated. You’ll have to submit additional paperwork to prove the stability of your income, the business’s financial strength and the business’s ability to continue to generate your stated income.
Other documentation: To start, lenders will ask for a copy of your driver’s license, your Social Security number and permission to run a credit report. They will request other documents depending on your history.
What’s the difference between pre-approval and approval?
You’ve submitted your application, and you’re ready to move forward with the loan. What’s the difference between pre-approval and approval for a mortgage? Aren’t you already approved?
After you submit your final mortgage application, a lender has three days to provide a loan estimate that outlines:
Pre-approved loan amount
Maximum loan amount
Terms and type of mortgage
Interest rate
Estimated payment
Estimated closing costs
Estimated property taxes
Estimated homeowner’s insurance
The loan will then move to the loan underwriter, which will review your application and all your information, ensuring you meet all specific guidelines and still qualify for the loan. Once the underwriter confirms nothing in your financial situation has changed, they move forward with the loan.
Final loan approval occurs when the appraisal is complete, all documents are approved and ready for signing and the loan is approved for closing.
Are you ready to be pre-approved for a mortgage?
Getting pre-approval for a mortgage is the smart thing to do when you’re in the market for a new house. It gives you bargaining power with sellers and the confidence to know you’ll be able to move forward with the loan you’re applying for.
Whether you’re a first-time homebuyer, are upsizing to your forever home or downsizing for your empty nest, the best place to begin is to be pre-approved for a loan. Contact a Home Loan Guide at Solarity to get started today.