Van's Real Estate - Helpful Information

HOUSE PAYMENT ( P I T I )

Determining Principle & Interest (P I TI )

     There can be up to 5 parts to a home mortgage payment.  Principle (P), Interest (I), Taxes (T) and Insurance (I) which together are commonly called PITI.  The 5th additional part is Private Mortgage Insurance (PMI) or similarly Mortgage Insurance Premium (MIP).

    Principle is that part of the payment which is used to reduce the amount borrowed or the loan amount.  In the beginning the amount of the principle is very small sometimes only dollars.  The Interest is the cost the lender charges for using their money.  In the beginning it is quite large but as the principle pays off the loan it is reduced over time and in the end is quite small. Together the Principle & Interest on a particular loan are enumerated on a Amortization Schedule which shows all payments scheduled to be paid throughout the life of the loan.  So a 30 year loan would have 360 payments showing how much principle and interest is being paid with each payment.   A formula and chart to obtain an amortization schedule is provided by Mortgage 101. Once all principle has been paid, the home is fully owned or clear of the mortgage.  

    The mortgage is the document which gives the lender the right to obtain the property if conditions in the mortgage have not been met.  Usually this would mean that payments have not been paid.  At closing the borrower signs a note where the borrower promises to pay back the money under an agreed arrangement  specifying  number of payments, interest rates and other conditions.  The  promissory notes is secured by the mortgage.  If the promise of repayment is not kept by the borrower then the lender under the provisions of the mortgage will file for ownership of the house.

   A calculator by Mortgage 101 can help you in determining the principle and interest (PI) of a loan given the amount, number of payments and interest rate.  In using their calculator make sure you deduct the down payment you would make since this would not be borrowed money.  

    In lieu of using a calculator the following table provides a limited payment schedule.  Find your selected interest rate along with  the respective years and locate the corresponding factor.  The factor is the dollar amount or monthly payment per thousand dollars of loan amount.  Thus if I wanted to borrow $130,000 at 7 1/2 % for 30 years , I would multiply 130 times the factor of 7.00 and end up with a payment (PI) of $910 .

% Rate	15 years	20 years	30 years	% Rate	15 years	20 years	30 years
5 3/4	8.31	7.03	5.84	7 1/4	9.13	7.91	6.83
6	8.44	7.17	6.00	7 1/2	9.28	8.06	7.00
6 1/4	8.58	7.31	6.16	7 3/4	9.42	8.21	7.17
6 1/2	8.72	7.46	6.33	8	9.56	8.37	7.34
6 3/4	8.85	7.61	6.49	8 1/4	9.71	8.53	7.52
7	8.99	7.76	6.66	8 1/2	9.85	8.68	7.69

         If you own (mainly for REALTORS and money managers in the business of lending money) a programmable HP calculator I have provided a formula which can be used to make all this very simple. By taking out the terms used in a TVM (time value of money) formula of n, PV and FV and using common english of loan, payment$, interest rate down payment and years the calculator becomes extremely user friendly.  The ease of use of the programmed calculator assists in helping the the customers while I am driving the car to look at houses, determine their own payment.  And so the story goes...

The Interest Rate (PITI)

    A customer sitting next to me while I was driving the car was stating his financial goals and how he did not want to exceed a payment he had established.  At the time we were looking at homes around $95,000 which was the limit he had established.  He started using my calculator and after providing the payment he wanted to make along with the current interest rate, etc. he looked at me and said "Is this true?  This calculator shows I can purchase a house around $125,000 and stay within my payment."  That afternoon he bought a house for about $127,000. Lesson here is to realize how important it is to establish a payment which fits into your financial goals .  The difference for the customer above was that his thought process was locked into a higher interest rate which he had used when he had bought his last home years ago.  He did not realize how much more purchasing power he now had with lower interest rates.  Small changes in interest rates have a large impact on the amount of house a person can afford.  Shopping for a good interest rate is as important as negotiating for that "good deal".  Often the difference on the interest rate will have more impact on your payment than negotiating dollars off the purchase price. 

    Consider, the length of the loan when you are figuring your payment.  A 30 year loan will provide the lowest payment.  If you are going to stay in the house for the duration or a longer time than the 7 year average, then a 15 year loan would save 15 years of payments with an increase in the payment of not too much more. Also when you consider a 15 year mortgage the lender will generally offer you a lower interest rate and the Private Mortgage Insurance (PMI) is less for the 15 year mortgage compared to a 30 year mortgage.

    Shop your interest rate.  I suggest using a mortgage lender located in the area you are buying your home.  Check at least two lenders to keep everyone honest.  Knowing there is competition between the lenders is the best means of achieving the lowest offer.  

    Economics 101 or Jim's philosophical musings on interest rates:  When I started a business, I sought financing using a CD note for security.  The bank stated they would charge 2% above the CD rate which was a CD from their bank.  Therefore in matters of borrowed money I figured a bank required a 2% margin to be profitable.  But, to maintain the value of the borrowed money they  must, on a long term loan, add in the expectation of inflation.  Again this appears to be true since my parents borrowed for their first house after the big war at 4%.  2% for the bank and 2% for anticipated inflation.  Today using old supply and demand we have competition for the borrowed dollar from the biggest debtor of all, Uncle Sam.  This adds the remaining increased amount to the current long term interest rate.  Now follow the logic, if inflation is anticipated to be lower in the future, long term interest rates will come down.  If the possibility exists that the great debtor is getting his books in order and a possible balanced budget, then again interest rates will come down. If the actual national debt starts to be reduced then long term interest rates will loose the added upward pressure created by the national debt and further come down.  The corollaries on the rates going up are also true. 

     All this is different for short term rates which are influenced by the FEDS Federal Reserve Board .  When they establish their rate at which they will lend money to banks, banks use this rate to decide on their prime lending rate which is the short term rate they charge their best customers (read GM, Sears, etc.) Short term rates influence the amount banks charge on their credit card and adjustable rate loan products.  Adjustable rate loans should strongly be consider if you are going to live in a home for a short term between 3 - 7 years.

Taxes (PITI)

    When our family first moved to the area (1988) and bought a house, I noted the property taxes we were going to pay.  I called my dad and told him that it looked like I would have to pay approximately $180 in property tax.  He said "Jim, that's what I pay".  I started laughing as I informed him that he was paying his figure monthly  where mine was an annual payment. 

    The property tax you pay in the state of Alabama is not a major factor which needs to be considered in you overall house payment.  Living in the county is cheaper than the city but the cost differential is minuscule. 

    To figure the property tax the following process is used:  

1. Tax assessor determines an appraised value on the property and its improvements (house, garage etc.).
2. The tax assessor's value is multiplied by a use factor 10% for homeowners who have filled their homestead, 20% for rental or investment property,. and 30% for utilities.
3. This figure is multiplied by a millage rate ranging from .022 (county), .028 (city), .035 (Montgomery).
4. Now this final amount can further be changed, approximately $43 is subtracted for homestead exemption,  In Elmore county $25 is added for fire protection but Elmore county has a lower millage rate where in Autauga county they charge a tad more but no $25.
5. So if you are buying a home with a tax assessor's value of $100,000 multiply by 10% = $10,000 multiplied by a millage of say .028 = $280 and finally subtract homestead exemption of $43 we now have our final figure of $237 or $19.75 per month.  If the higher millage figure would have been used the monthly cost would still have been under $26 per month.

    One should note with caution the credibility given to the tax assessor's appraisal of the property.  It has no real bearing on the market value or sale price of a home.  Generally these values are less then what the house will finally appraise for by a certified appraiser.

Insurance (PITI)

    Home Owners insurance, sometimes called fire insurance, hazard insurance or property insurance is required by the mortgage lender and common sense to protect a rather sizable investment from damage in certain situations.  Insurance on homes is determined by the value of the home, its contents, type of insurance, deductible, location of the home and its proximity to a servicing fire department and fire hydrant.  The insurance companies together have assigned category ratings from 1 (the best) to 10.  These categories are used by all the insurance companies (except USAA) and are based mainly upon property location and servicing fire department.  Generally, a home is a category 2 in Montgomery, a 4 in Prattville, A 5 in Millbrook & Wetumpka and if you are outside the city but within 5 miles of a servicing fire department and 1000 feet from an approved fire hydrant then you may be a category 6.  A category 9 is given to rural property within 5 miles of a voluntary fire department and finally a category 10 is given if no one is going to help you put out when the flames appear.  From a 2 to a 10, insurance can almost double.  A higher deductible (possibly even $1,000) should be considered if you are anything higher than a category 6.  For homes in a category 2-4 generally a $250 deductible makes the best sense. 

    Replacement coverage should be what you first consider.  With replacement coverage the item is replaced. If lightning hits my home and takes out my vintage TV set under a non replacement coverage they tell me my set is 15 years old and has a value of $25.  I tell them $25 is not going to solve my problem.  If I had replacement coverage they would have replaced the item with one in kind so I would have ended up with a new 28" color great for those early colorized episodes of Bonanza.  All this is subject to paying my deductible which in the first case would have left me with nothing.

 In this area I use Danny Strock as my insurance agent who represents Cotton States Insurance phone # 334-365-6555, address; 984 E Main Street, Prattville, AL 36066. 

I have also had very positive dealings with Joe Hall who represents State Farm and would recommend him, phone # 334-270-2723  address; 6940 Vaughn Road, Montgomery, AL 36116

Mike Childs is with Farmers Insurance Group, phone # 334-361-8111 address; 1345 S Memorial Drive, Prattville, AL 36067. 

I value these  agents for their professionalism and the commitment they make to their clients. All of the above agents provide insurance in all three counties.  USAA historically has a higher premium in this area on homeowners insurance and ALFA has competitive rates but also charges a membership fee of approximately $25 which is never included in their insurance premium quote.  For more helpful information general information on insurance check out  insure.com  "The insurance Guide" FAQ.

What about MIP or PMI

   The mortgage lender desires to lend you 80% of the appraised value for your property and improvements (house).   Since most people do not have the required 20% to put down, the lender will require insurance to protect their investment.  The less money a person puts down the higher the cost of the insurance.  But there is no requirement for mortgage insurance if the buyer puts 20 % down. 

    When a person buys a house using an FHA loan, the FHA require a Mortgage Insurance Premium.  The MIP is 2.25% of the loan value at time of closing.  This amount can be added to the loan amount and would not be required as cash above the down payment.  Plus the 2.25% up front, they will also require a half of a percent .5% of the mortgage amount divided by 12 for a monthly fee which is added to the payment.  So if the house was $80,000, the FHA would require $1800 at closing which could be added to the loan and a monthly fee of $33.34 added to the monthly payment.  Check with the mortgage lender on if and when the MIP can be removed from the payment and what would be needed for this to occur. 

  When a person buys a house using a conventional loan any number of Private Mortgage Insurance products can be used if more than 80% of the home appraised value is borrowed.  Just one set of premiums with no additional upfront costs for a 30 year loan would be:   for 5% down an additional monthly fee added to the payment .78% of the mortgage amount; for 10% down .52%; and for 15% down .35%.   Again these costs would be less on a 15 year loan. There are multiple companies offering these products and any number of products for each company.  This needs to be discussed with the mortgage lender as to which product would best serve your needs.

    A new product being offered by some mortgage lenders is increasing the interest amount on the loan to cover the cost of the PMI (no difference in payment).  The advantage of this product is the higher interest on the mortgage can be used as a tax deduction where PMI cannot be used by a home owner for a tax deduction.  Bad part about this program is the interest rate on a fixed loan will not change even if the owners eventually acquire 20% equity in their property unless the home is refinanced.  And finally a new product called 10-10-80 is where the borrower put down 10% and borrows a traditional mortgage loan of 80% with the bank providing a short term loan for the remaining 10% which pays off sooner.  This program eliminates the PMI and all interest payments which are paid are deductible on you taxes if you itemize vs PMI or MIP which is not deductible.

QUALIFYING FOR A LOAN

Income vs Debt

    When the qualifying mortgage lender "qualifies" you for a loan they are doing so using a book of rules published by the secondary lending institution, the company that buys the loan from the originator i.e. Fannie Mae , or Freddie Mac.   Although this is not particular important what is important is that they are all going by the same rule book.  So the ratios needed for one loan company will be the same for other loan companies.  This is not true if the lending institution, a bank, is not going to sell the loan to a secondary lending institution.  The banks can loan using a different rule book, mainly banking guide lines etc.  If a fairly new doctor is trying to qualify using conforming guidelines, he or she based upon a high debt load from students loan will probably not qualify under conforming guidelines but in most cases can find a bank willing to loan them money for a house.

    How Much Can I Afford (PreQual (by mortgage 101) is a good start providing a number of work sheets to assist in qualifying you for a particular amount.  Other than using the calculator a simple approach is to understand that the lending institution on a conventional loan desires to keep your debt ratio under 36%.  To figure use this figure, take your gross (pre tax) monthly income and multiply by .36  This is the amount the bank will allow for your debt payments (monthly minimum credit cards, unsecured loan payments, alimony, child support payments etc.) AND your house payment.  Not includes are your normal living expenses i.e.. food, clothing, taxes, insurance, etc.  This is a rather simplistic approach but provides a ball park figure for planning purposes.  The government insured loans (VA), (FHA) are allowed a higher debt ration and in some cases can even exceed 41%.  Thus you can use .41 to multiply your gross monthly income.

The Credit Game

    I met a couple desiring to buy a home who had filed Chap 13 Bankruptcy.  After discussions with the local mortgage lender, there may be a strong possibility on them obtaining a loan.  Surprised!  Every one can qualify for a home.  I say this because I know the credit file maintains entries for only 7 - 10 years.  So it is never IF a person can qualify for a house but rather WHEN can a person qualify after maintaining good credit.  If there are a number of slow payments then a period of time say 6 months to a year of good credit can go a long way in helping the person to qualify for the loan.  The BIG killers, show stoppers, or items needing a longer time to be forgiven  (remember most all things are forgiven in time) include: 1. Late rent or mortgage payments, two in a year is a killer,  2. Late payments on a government student loan. 3. A "charge off" which is when a lender has written off the loan to a collection agency and would appear as a category 9 on the credit report.  Late payments are not a total killer unless a pattern emerges on the credit report. 

    The new qualifying procedure is to have the credit report scored by the "Computer" and a number assigned between 300 and 850.   The computer scores the credit report by comparing your report to millions of other reports and determines where you "fit in".  It goes with out saying that it is extremely important that you credit file is up to date and correct.   You will find more information and additional links on our "Free Credit Report page"

Additionally check out Mortgage 101 and their Credit Rating page which contains 10 categories and touches on a myriad of topics dealing with credit reports and credit scores.