How to Structure Your Mortgage Deal (Hint: You need to understand interest rates!)
An all-in-one mortgage structuring guide for first-time home buyers

They say there’s no time like the present, and in the case of home buying this advice couldn’t be more accurate.

The housing market is hot right now, and with homes being bought up at unprecedented rates you’ll want to seize the opportunity before it’s too late.

If you’re a first-time buyer, you probably know there’s a lot to learn.

Your loan principal, taxes, closing costs, and insurance should all be on your list. But one element of homeownership trumps the rest: interest rates.

Understanding interest rates and how exactly they work can be the most important factor in terms of your mortgage (and of course, your wallet).

So, follow along as we explain the finer details of structuring your first mortgage, and what interest rates mean for you as a first-time buyer.

What’s PITI?

PITI is an acronym—it stands for principal, interest, taxes, and insurance.

Think of PITI as the starting line of your home buying journey.

Without understanding this acronym and its features, chances are you won’t get very far in the home buying process. Especially because the bank uses PITI to decide if they’ll offer you a loan.

PRINCIPAL

Let’s begin with principal. This is the amount you’ll owe on the loan before interest.

So, if you buy a home for $300,000 with a 20% down payment (60,000) your loan principal will be $240,000.

That might not seem like much for a 15 or 30-year mortgage, but keep in mind that you’ll end up paying a lot more in interest.

When lenders look at the principal you’ve requested, they’ll consider your debt-to-income (DTI) ratio. So, before you decide on an amount, you’ll want to make sure your total debts divided by your income are less than 43%.

If that percentage is any higher, you’ll probably have trouble making your monthly mortgage payments, and the lender won’t be keen to work with you.

INSURANCE

When you’re structuring your loan, the lender will typically require that you pay property insurance on your home.

And don’t forget you may have to pay HOA fees, and you might want to take out additional insurance for your valuable investment.

Just like taxes, the cost of property insurance will vary by region, urban/rural living, and various other factors.

Not to mention, if you can’t afford a 20% down payment upfront, the lender will usually force you to pay private mortgage insurance or PMI.

PMI is for the bank’s security, not yours. It ensures they’ll get their money back for taking a greater risk.

It will be tacked onto your monthly mortgage payment, and you should expect to pay anywhere from 0.5% to 1.5% of your loan amount per year.

TAXES

Next, you’ll want to consider taxes and insurance when structuring your loan (we’ll save interest rates for last).

When you begin paying off your loan, you’re going to be forced to pay taxes and insurance. These categories are easy to overlook, but they’re a vital piece of your mortgage structure.

For many homeowners, property taxes are the most expensive—these will vary depending on where you live, so be sure to do some research beforehand.

Make sure to include closing costs and appraisal fees in your calculations too. The average in the U.S. starts around $5,000, but this will depend on where you live as well.

Overall, you can expect to pay $1 for every $1,000 of value in your home. So, if your house is worth $300,000 you’ll probably pay $300 a month in taxes or $3,600 per year.

INTEREST

The last part of PITI is the most important. If you’re not careful, your interest rates could become a ball and chain on your bank account for years to come.

So, let’s return to our $300,000, 30-year mortgage. With a 4% interest rate you’ll pay around $1,432 a month on the mortgage payment alone.

That might be within your means as a buyer but beware of front-end loading.

Essentially, the bank makes you pay more in interest at the beginning of your loan term to ensure they’ll get their money upfront.

So, you’ll pay $1,432 per month, but initially you’ll pay $1,000 of it towards interest. That’s money going to the lender’s pocker, NOT towards paying your mortgage principal off!

That number will decrease over time, but in our scenario you’ll have paid around $215,608 in interest on top of the $300,000 principal by the end of your loan term.

So, you might try to negotiate your interest rate down. If you decrease that interest rate from 4% to 3%, the amount of interest you’ll pay drops to $155,332.

Great! So you’ll look for the lowest possible interest rate, right?

Not quite—your lender has a few more tricks up their sleeve. Due to a little feature known as interest rate vs. interest volume, an ultra-low interest rate could work against you.

Why Worry about PITI?

By now you’re probably wondering: what does this mean for me?

Well, as a first-time buyer, the bank might steer you towards mortgage plans that look attractive on the surface but will end up costing you thousands more in the long run.

You’ll want to use PITI to calculate what you can afford because the bank will be using PITI to decide whether or not you’re worth lending to.

Generally, your lender will be looking for a total PITI mortgage calculation of 28% or less, relative to your household income.

Adjustable vs. Fixed Rate Mortgages

When you begin structuring your mortgage to fit your needs, you’ll usually have an option of an unvarying (fixed) rate or adjustable mortgage interest rate.

The mortgages we’ve already considered are fixed rate. Your interest rate stays the same for your entire loan term, which generally means paying a lot in interest to the bank.

Adjustable-rate mortgages (ARM) are a bit more complicated.

In brief, your interest rate stays the same for a set period—anywhere from a month to 10 years—and then rises (or falls) according to the market index.

This type of mortgage is tricky—even though you’ll save a lot initially, interest rates can skyrocket depending on how the market performs.

So, if you plan to take on more debt in the future, or if you don’t think you’ll be able to cover the cost of an adjustable rate then this probably isn’t the best option for you.

Your Mortgage Term

The foundation of your loan payment is the loan term. The bank will offer you a 15 or 30-year mortgage, and each has its pros and cons.

15 Years

Remember how interest stacks up over time? Paying off your mortgage in 15 years means you’re giving less to the bank—if you can afford the monthly payments.

Let’s say you go with a $300,000 fixed rate, 15-year mortgage. Even with a low-interest rate of 2.5%, you’ll pay around $2,000 a month!

So, the advantage is that you’ll generally pay less interest, but if you’re not able to keep up with the steep monthly payments you could fall into debt quickly.

30 Years

So, maybe a 30-year loan term is the better option?

It’s more common, and your monthly payments will be a lot lower. But as you saw earlier, you’ll probably pay hundreds of thousands in interest.

That’s profit for the bank, and less money in your pocket for your family, your lifestyle, and your other investments.

Not 15 Years, Not 30…

When it comes to structuring your mortgage, you’ll want to consider your options carefully.

Even if you feel prepared to take on a pricey mortgage, you never know what expenses might come up in the future.

So, maybe you feel like you have to choose from the lesser of two evils.

On top of all the extra fees you’ll end up paying for, you have to choose between stretching your finances thin or paying the bank hundreds of thousands in interest.

This has been the unfortunate reality of homeownership for decades, and for a while there wasn’t a better solution.

So, we spent years developing one.

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$2 Billion and Counting…

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If you’re ready to take back your financial freedom, visit our homepage to learn more, or give us a call. Our representatives are standing by to help you take the first steps towards a debt-free life.

Still have questions?