5 Pitfalls to Avoid in the Mortgage Calculator
Mortgage calculators help us answer a number of important questions. How much house we can afford to save money on a refinance calculator provides the data we need to make critical financial decisions. As reported by CFPBhowever, we should not blindly follow the results of a mortgage calculator.
In fact, there are several pitfalls to avoid when using a calculator to make home buying or refinancing decisions.
1. What goes into a mortgage payment
A mortgage payment often combines five different expenses. There is, of course, the payment of principal and interest. In addition, many mortgage service companies collect insurance, property taxes, and private mortgage insurance. A mortgage calculator should account for all of these potential payments
In our case, my wife and I pay close to $1,000 a month in property taxes and home insurance alone. Excluding them from the calculation would significantly underestimate our actual monthly payment. Karl’s Mortgage Calculatorone of my favorites, accounts for all of these potential expenses.
2. HOA Fees
As an investor, one thing I try to avoid is buying rental property that comes with homeowners association fees. HOA fees eat away at a property’s cash flow, especially in the early years of a leveraged property. In the case of a landlord, however, some of the best communities come with HOA fees, like it or not.
The key is to make sure you consider these fees when making a purchasing decision. Although many calculators do not include these fees, they should. According to Investopedia, HOA fees can range from $200 to $400 per month. In expensive parts of the country, the fees can be even higher.
3. Interest rate
For a mortgage calculator to work, you need to know the interest rate of the loan (you can find current mortgage rates here). If you’ve just started looking for a home, you probably don’t know the interest rate for your potential mortgage. These rates are influenced by a number of factors:
- Deposit amount
- Your FICO credit score
- house cost
- Location of the house
- Your income
- Your debts
- Type of mortgage
Getting the right interest rate is essential with a mortgage calculator. Even a small difference in the rate can have a big impact on both the monthly payment and the total amount of interest you’ll pay over the life of the loan.
For example, on a $300,000 mortgage, the difference between a 4% and 4.5% mortgage rate is almost $90 per month. Over the term of a 30-year mortgage in our example, the 4.5% rate will incur an additional interest payment of $32,000.
Mortgage interest on most owner-occupied homes is deductible for those who itemize their deductions. The deduction has the effect of reducing the effective interest rate of the mortgage loan. For example, an interest rate of 4% translates into an effective rate of 3% for those who pay 25% tax at the margin.
Property taxes are also deductible. Depending on your marginal tax rates, the tax savings can be significant. Taxes are often ignored with many mortgage calculators.
5. Closing costs
Finally, closing costs are often omitted from many mortgage calculators. However, as the CFPB points out, closing costs can be significant. These costs will vary depending on the location of the home, the purchase price, the down payment and other factors.
Bank of America offers free service closing cost calculator (yes, another calculator). Using the calculator and assuming a purchase price of $500,000 in Northern Virginia, the estimated closing costs exceed $13,000, broken down as follows:
- Bank of America fee: $4,138
- Third party fees: $6,384
- Estimated prepaid interest and insurance: $1,470
- Estimated escrow account funds: $1,736
In some cases, the buyer may be able to negotiate for the seller to pay a portion of these costs. The closing date can also affect these fees (the closer to the end of the month, the lower the prepaid fees). But don’t underestimate closing costs. They are significant.
Mortgage calculators can be a great way to start the process of buying or refinancing a home. But keep in mind that they are only as good as the data you feed them. For the complete picture, be sure to consider each of the above factors and recognize that early in the process you may not have all the data you will ultimately need to generate an accurate estimate.