There are several different kinds of costs you pay when taking out a mortgage. Some of these costs are directly related to the mortgage – collectively, they make up the price of borrowing money. These costs are the ones you should focus on when choosing a mortgage.
Other costs, such as property taxes, are often paid with your mortgage, but they’re really costs of homeownership. You would have to pay them whether or not you had a mortgage. These costs are important in deciding how much you can afford. However, lenders don’t control these costs, so you shouldn’t make decisions about which lender to choose based on their estimates of these costs.
You pay for a mortgage in two ways: upfront and over time. When choosing a mortgage, it’s important to look at both types of costs. A mortgage with a lower monthly payment may have higher upfront costs, or a mortgage with low upfront costs may have a higher monthly payment.
Monthly costs. Your monthly payment will typically contain four elements:
Principal. This is the money you borrowed and have to pay back. This is part of the cost of buying your home, but not a cost of borrowing money.
Interest. This is the primary cost of borrowing money, but not the only one.
Mortgage insurance. This is an additional cost of borrowing money, typically required for borrowers who make a down payment of less than 20%.
Property taxes and homeowners’ insurance. These are costs of homeownership, not of borrowing money. They are usually bundled with your monthly payment and managed by the lender through an escrow account.
Upfront costs. In addition to your down payment, you have to pay for several different kinds of costs at closing.
Origination and lender charges. These costs are charged by the lender for “originating,” or making you the loan. They are part of the price of borrowing money. Different lenders may choose to itemize these costs to varying degrees – it’s the overall total that matters. Common charges are labeled origination fees, application fees, underwriting fees, processing fees, administrative fees, etc.
Points. Points are a charge you pay upfront to the lender. Points are part of the price of borrowing money and are calculated as a percentage of the loan amount. You can choose whether or not to pay points. Learn more about points.
Taxes and government fees. These fees are charged by your local government. They are charged in connection with the real estate transaction, but are usually not a cost of borrowing money.
Prepaid expenses and deposits. These expenses may be associated with your loan or with homeownership. Typically, you need to pay the interest on your loan between the time you close and the end of that month. It’s also common to pay the first year’s homeowner’s insurance premium and make initial deposits into an escrow account to cover future homeowner’s insurance and property taxes.