Your monthly payment amount is dependent on several things, not just how much you are borrowing and the interest rate you get. Those are the two most important things, of course: the more you borrow and the higher your interest rate, the more you will pay each month. But there are a number of other factors that affect your payment amount. These can include:
Teaser Rate – Some loans start off with a lower payment that later adjusts to a higher one. This can be a “teaser rate” that is part of an adjustable rate mortgage (ARM), or it might be a builder or seller-sponsored promotional feature to entice you to buy the property.
Loan term – This is the expected “life” of the loan, usually referred to in years. A 30-year loan is typical these days, but a generation or two ago, 20-year loans were more in use. The longer the term, the lower the monthly payments, but the more interest you pay in the long run. “Life of the loan” is an appropriate term for another reason. As the loan counts down to zero months over time, it is said to “amortize,” which is from a French word for “death.” The loan amortizes little by little with each payment, until the debt is retired, or “dies,” in effect, in month zero.
Taxes and insurance – Above certain loan to value ratios (LTV), lenders will insist on collecting taxes and insurance along with your principle and interest payments. This is because if you don’t pay your property taxes, their loan security can be threatened by tax liens imposed by the local government. If the property isn’t insured and there is a fire or other disaster, the lender is left holding the bag. So they will estimate your property taxes and hazard insurance premium and require 1/12th of the annual amount each month. You’ve probably heard the term, “P.I. payment” before. This stands for “principal and interest due each month. The term, “P.I.T.I. payment” is short for principal/interest/taxes/insurance due each month.
PMI – Private mortgage insurance is required if you put less than 20% down on your home when you buy it. This insurance, like FHA insurance on a government loan, protects the lender against loss if you default. PMI has an upfront premium and an annual renewal premium that is charged monthly. The benefit of PMI to you is that without it, you wouldn’t be able to obtain a loan with less than a 20% down payment.
Down payment and Loan to Value (LTV) – The down payment is the amount you bring to the transaction to reduce the sales price of the home. You are used to seeing this when you have bought other expensive items such as a car. The more of your own money you have in the transaction, the lower the lender’s risk and therefore, the lower the interest rate you typically are expected to pay. The loan to value, or LTV, is a different way of looking at the same thing. If you put 25% down, your LTV will be 75%. If you put less as a down payment, the higher your LTV will be, and often, also the interest rate you will be expected to pay, as the loan becomes riskier for the lender. “Equity” is still another way of looking at it. The more equity you have, the lower your LTV, and the less likely you are to default on your loan.