|Homebuyer Top Stories||Homebuying Q&A: Ask Our Expert|
Q: Are car loan payments calculated differently than mortgage payments?
A: Monthly payments for some auto loans may not be calculated the same way a mortgage loan is.
For mortgages, the process of amortization is essentially a compounding method. A good way to think about mortgage amortization is that you don't have one single loan, but rather individual loans with terms of 360 months, then one for 359 months, then one for 358 months and so on, all strung together.
Each month sees a payment calculated with a smaller loan balance over the new shorter term, and while the total of the payment remains the same, the amount of interest you pay in a given month decreases while the amount of principal you pay increases.
This is a process known as "amortization." To determine your monthly mortgage payment over the life of your loan, be sure to check out our mortgage calculator.
On the other hand, installment loans--like a car loan--can either be:
- "Simple interest add-on" or
- "Simple interest amortizing"
Simple interest add-on loans: These are actually written as a single loan; all of the interest that will be due is calculated up front, added to the total of the loan as a finance charge, then that sum is divided over the number of months in the term to arrive at your monthly payment. Each payment consists of exactly the same amount of principal and interest, and as such, there's no savings to be had from prepaying these kinds of loans early.
Simple interest amortizing loans: These work like a mortgage, with a declining loan balance and declining term producing a constant monthly payment with changing compositions of principal and interest. Prepaying these can save you some money.
A loan to avoid
There can also still be loans based upon a thing called the "Rule of 78."
These are simple interest add-on loans with a twist; they are structured to have you pay the interest due on the loan first, then once that's done, your payments will cover the principal.
These should be avoided, since you end up "renting" money during the early years of the loan while your principal doesn't decline. If you should hold the loan to term, there is no difference in total cost when compared to a standard simple interest add-on loan, but if you should need to pay the loan off early, you'll find that you'll still owe most -- if not all -- of the original loan you took despite having made payments for some period of time.
Depending upon your kind of loan, you'll be able to use a standard amortization calculator... or not. Check your loan contract for details; if it is a "simple interest add-on" type, do a Google search for "simple interest calculator" and you should be able to find what you need.
Are you ready to buy a home?
Chances are your home purchase will be the largest transaction you embark on over the course of your lifetime. That in itself is reason enough to make sure you’re not only prepared but well-educated when it comes time to buying your home. Shopping for your mortgage is at least as important as shopping for your home, because the right home loan can save you tens of thousands of dollars. Especially for first-time homebuyers, the more you understand about your mortgage and the homebuying process, the better off you’ll be and the more money you’ll save.
Before you begin shopping for a home loan, you need to ask yourself a few questions:
- How much home can I afford?
- How long do I plan on staying here?
- Am I ready?
Before you worry about Realtors, property listings or locking in a mortgage rate, you must first determine how much home you can afford. HSH.com offers homebuyers several home loan calculators that can help give you a sense of your level of affordability. Our How much house can I afford calculator is just the tool to get you started. Simply plug in a few sets of numbers (e.g., annual income, projected down payment, your monthly bills) and you’ll get a sense of your price range.
However, while affordability calculators can certainly give you a good starting point in terms of learning how much house you can afford, only you truly know how well a monthly mortgage payment, not to mention taxes and insurance, will fit into your budget and lifestyle.
On paper, you may qualify for a lot more or a lot less than you should spend. So when determining what you can afford, sketch out what you think your life may look like one, five or 10 years down the road. Look at your goals and what kind of money you need to meet them, and where it's going to come from. Decide what payment works for you, and then enter current mortgage rates into our home loan calculator to find a projected loan amount and maximum purchase price.
This brings us to the next big question: How long do you plan on living in the house you’re buying? Is this a starter home or a place you see yourself raising your family in? Understanding your life’s plans and future goals is not only crucial in deciding how big a home you should buy, but finding the right mortgage product to match.
Sure adjustable rate mortgages have gotten a bad reputation over the last few years, but if you aren’t planning to stay in your prospective home very long, these adjustable-rate products offer the opportunity to take advantage of even lower mortgage rates.
Yet remember, it’s hard enough to make plans for the upcoming weekend let alone five, 10 years down the road. This is why most homeowners prefer the stability that comes with a 30-year fixed rate mortgage. If mortgage rates do fall in the future, you can always crunch the numbers to determine if a refinance can save you cash each month.
Are you up for the task?
HSH.com visitor and recent first-time homebuyer Eric told us that when he and his wife went to look at houses with their real estate agent, they could tell a home “just wasn’t for them” before even stepping foot out of their car. Yet finding and maintaining your dream home has to do with a lot more than just aesthetics.
Owning a home is about a lot more than simply being able to afford your monthly mortgage payments. There are recurring maintenance costs to consider (you should budget saving at least 2 percent of your home’s value each year for repairs), property management costs to plan for (if the home you’re buying has a decent-sized property, you will have to dedicate a lot more time and money to your investment as opposed to someone who purchased a condo or townhome), and those unexpected emergencies (like your water heater bursting in the middle of the night) that you’ll surely have to deal with.
We asked first-time homebuyer Michael Herley from Coatesville, Pennsylvania what was the one thing he wished he knew before buying his home. “I wish I would have appreciated the gravity of purchasing a house,” he explained. “Don't get me wrong, our place is beautiful and I love it, but the work that goes into everything is much more than one could ever know. Do not think that your work is over once you have found your dream home -- rather it has just begun.”
Continue your education
As Mr. Herley mentioned, once you’ve found your dream home, the work has just begun. On a daily basis HSH.com publishes new information for not only homebuyers but for homeowners as well on a wide-range of topics. We cover everything from how to find the best real estate agent, to mortgage rate forecasts, to home equity loans, refinancing and home maintenance. Good Luck.