Mortgage calculators help us answer a number of important questions. From how much house we can afford to saving money on a refinance, a calculator provides the data we need to make critical financial decisions. As reported by the CFPB, however, we shouldn’t blindly follow a mortgage calculator’s results.
In fact, there are several traps to avoid when using a calculator to make home purchasing or refinancing decisions.
1. What goes in a mortgage payment
A mortgage payment often combines five different expenses. There are, of course, the principal and interest payments. In addition, many mortgage servicing companies collect for insurance, real estate taxes, and private mortgage insurance. A mortgage calculator should factor in all of these potential payments.
In our case, my wife and I pay almost $1,000 a month just in real estate taxes and homeowner’s insurance. Excluding these from the calculation would significantly understate our actual monthly payment. Karl’s mortgage calculator, one of my favorites, factors in all of these potential expenses.
2. HOA Fees
As an investor, one thing I try to avoid is buying a rental property that comes with Homeowners’ Association Fees. HOA fees eat into a property’s cash flow, particularly in the early years of a leveraged property. In the case of a homeowner, however, some of the better communities come with HOA fees, like it or not.
The key is to make sure you factor in these fees when making a purchasing decision. While many calculators don’t include these fees, they should. According to Investopedia, HOA fees can range fro $200 to $400 a month. In expensive areas of the country, the fees can go even higher.
3. Interest Rates
For any mortgage calculator to work, you need to know the interest rate on the loan. If you are just starting the search for a home, you likely don’t know the interest rate on your eventual mortgage. These rates are affected by a number of factors:
- Amount of the down payment
- Your FICO credit score
- Cost of the home
- Location of the home
- Your income
- Your debts
- Type of mortgage
Getting the interest rate right is critical 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 four percent and 4.5% mortgage rate is nearly $90 a month. Over the life of a 30-year mortgage in our example, the 4.5% rate will result in paying an extra $32,000 in interest.
Mortgage interest on most owner-occupied homes is deductible for those who itemize their deductions. The deduction has the effect of lowering the effective interest rate on the mortgage. For example, a four percent interest rate translates into an effective rate of three percent for those paying 25% in taxes at the margin.
Real estate taxes are also deductible. Depending on your marginal tax rates, tax savings can be significant. Taxes are often ignored with many mortgage calculators.
5. Closing Costs
Finally, closing costs are often left out of many mortgage calculators. As the CFPB points out, however, closing costs can be significant. These costs will vary based on the location of the home, purchase price, down payment and other factors.
Bank of America offers a free closing cost calculator (yes, another calculator). Using the calculator and assuming a $500,000 purchase price in Northern Virginia, the estimated closings costs exceeding $13,000, broken down as follows:
- Bank of America fees: $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 to have the seller pay some of these fees. The date of closing can also affect these fees (the closer to the end of the month, the smaller the prepaid fees). But one should not underestimate the closing costs. They are significant.
Mortgage calculators can be an excellent way to start the home buying or refinancing process. But keep in mind that they are only as good as the data you provide them. For a complete picture, make sure to account for each of the factors above, and recognize that early in the process you may not have all of the data you’ll ultimately need to generate an accurate estimate.