Mortgage Rates 101

Buying a home is one of the most important investments a person will ever make in his or her lifetime, so understanding the mortgage calculation process is very important if one wants to get the best deal possible. On most real estate websites, one will find a mortgage calculator. All that is required is for an interested person to enter specific information in the form fields provided. The system will automatically calculate the monthly payment for the mortgage.

For example, a down payment of $45,000 toward a $225,000 mortgage loan will equates to a total monthly payment of $1,532, at an interest rate of five and a quarter percent (5.25%). This value depends entirely on the zone, zip code, or area in which the home is located. Each zone has different tax rates, which will affect the total monthly payment. A zip code with a higher tax rate than 11798 will cause the monthly mortgage to be a lot more, although the down payment, purchase price of the home, and mortgage rate is the same in both areas.

The $1,532 monthly payment is the total result of the principal & interest payment ($994.00) and taxes & insurance payments ($538.00) combined, so without taxes and insurance, the mortgage payment would have been $994.00. This is why it is so important to make sure one knows the tax rates in a given area before deciding to buy a home in that area. This example also shows that private mortgage insurance or PMIs can increase the overall monthly mortgage. What does this mean? This means that one should avoid paying mortgage insurance at, all cost, by paying more than 20% down payment toward the purchasing price of the home one is interested in buying.

Therefore, instead of paying a down payment of $45,000, which is 20%, toward a $225,000 mortgage loan, a $55,000 down payment would have eliminated the mortgage insurance all together because that amount equates to 24.44% of the purchasing price of $225,000. This is if the bank or lender is reminded that more than 20% of the mortgage has been paid. It is therefore the borrower's responsibility to see to it that the bank or lender cancel any mortgage insurance on the loan. Creditors are required by law, to cancel a PMI if more than 20% of the loan has been paid off.

The calculation above was set to a 30-year fixed rate mortgage instead of a 15-year fixed rate mortgage. The 30-year mortgage is a lot cheaper on a per-month basis; however, one ends up paying more in the long run. A 15-year home loan usually comes with a slightly lower interest rate than that of the 30-year programs. In addition, it costs more per month, but the borrower pays less interest overall.

A 0.5% maximum point was set in our calculation. This is a percent of the amount that borrowers typically choose to pay to the lender in order to lower the mortgage rate. It is sometimes referred to as a buydown. Paying more discount points at the closing lowers the mortgage rate, and paying less raises the rate. This amount is collected at the closing. One discount point is equal to one percentage point of the loan amount. Discount points are very important when trying to keep mortgage expenses to a minimum.

All calculation above was done using the fixed rate mortgage program. Therefore, the mortgage rate does not change in accordance to interest rates set by the Federal Reserve, the central banking system in the United States that regulates the financial infrastructure of the economy to maintain stability. In a fixed rate mortgage program, the borrower's monthly mortgage payment does not change in response to the interest rate set by the Federal Reserve. In fact, lenders or banks will set their lending rates to two percent above the rate set by the Federal Reserve. So, if the rate set by the Federal Reserve is 3.25%, the rate set by creditors will normally be 5.25%.

In an adjustable rate mortgage program, the mortgage interest rate goes up or down depending on the direction of interest rates imposed by the Federal Reserve. The advantage of adjustable rate mortgage is that interest rates are usually set lower than that of fixed rate mortgages. Another advantage in using adjustable rate mortgage is when the Federal Reserve lowers interest rates. In this scenario, the borrower pays less on the mortgage each month. The disadvantage arises when interest rate increases. This means that the borrower has to pay more on the mortgage each month.

There is important information that homebuyers should be familiar with before embarking on the home buying journey. A knowledgeable home buyer will be more capable of making the right decision when it comes time to make crucial decisions. Therefore, learning the basics of mortgage acquisition and all the important information that comes along with it is paramount in getting a mortgage at the right price.