There are several factors that impact a mortgage and the payments associated with them, including loan values. Depending on the price you agree to pay for a home and the amount of money you need to borrow to make the purchase, your loan value can vary.
Obviously, the more money you can gather to put towards a down payment, the less you would have to borrow from a mortgage lender. The opposite is also true: the less money you put down, the more money you'd have to borrow, which would increase your loan value.
The question is, how does the overall loan amount affect your mortgage payments?
More Money Borrowed = Higher Mortgage Payments
There are a few things that impact mortgage payment amounts that first-time homebuyers should know. The loan amount is the most obvious. Essentially, the more money you borrow, the more you have to pay back, which typically translates into higher mortgage payments. At the end of the day, the amount you have to borrow will impact your mortgage payments every month.
Loan Time Periods
Not only does the amount that you borrow affect your mortgage payments, so does the mortgage term. The longer the term, the more time you have to pay down your mortgage. In this case, your mortgage payments would be lower because the loan amount would be spread across many more payments. On the other hand, a shorter home loan term would translate into higher mortgage payments, because you don't have as much time to pay off your loan.
Common home loan time frames include 15-year, 25-year, and 30-year mortgages. The one you choose will have a direct impact on how much you pay every month. While a shorter loan term can help you pay off the mortgage much faster than a longer loan term, the monthly mortgage payments will be higher. On the other hand, a longer mortgage term might reduce your mortgage payments, but it will take you much longer to pay down your mortgage. Not only that, the mortgage would cost you more overall because you'll be paying more towards interest, which brings us to our next point.
The loan-to-value ratio (LTV ratio) is an important factor that is used by lenders to not only determine whether or not to approve a mortgage, but also what interest rate to charge. Borrowers with a high LTV ratio - which is defined as the loan amount compared to the appraised value of the home - are typically perceived as a higher risk to lenders. As such, lenders tend to charge a higher interest rate in order to protect their investment.
Since your LTV ratio directly affects your interest rate, it affects your mortgage payments as well. The higher the interest rate, the more expensive your overall mortgage will be. As such, your mortgage payments will be higher, especially if your loan period is short.
For instance, a 15-year mortgage term would make each mortgage payment higher compared to those of a 30-year mortgage term. The less time you have to pay down your loan amount, the higher the payments will be.
Loan-to-value ratios that are higher than 80 percent for conventional mortgages will be subject to Private Mortgage Insurance (PMI), which is a type of insurance that is meant to protect lenders. In order to mitigate risk for lenders who loan out money to borrowers with less than a 20 percent down payment, mortgage insurance is typically required.
PMI is calculated based on a certain percentage of the original purchase price of the property. The percentage paid depends on the loan-to-value ratio. The higher the LTV ratio, the higher the percentage paid, which ranges from anywhere between 0.3 percent to 1.15 percent.
This insurance premium is added to the mortgage payment every month, which makes these payments more expensive. If you can reduce your loan-to-value ratio to under 80 percent, you can avoid having to pay this premium and reduce the amount you're responsible for paying every month.
How the Loan-to-Value Ratio is Calculated
Loan-to-value ratios are easily calculated. Basically, the total home loan amount is divided into the purchase price of the home. For example, if the subject property is purchased for $500,000 and a loan of $400,000 is taken out, the loan-to-value ratio would be 80 percent. That means 80 percent of the home's purchase price would need to be borrowed from a lender.
Lenders with conventional loans typically offer better mortgage terms to borrowers with loan-to-value ratios that are no higher than 80 percent.
Final Thoughts For First-Time Buyers
The loan value of your mortgage has a direct impact on the amount you have to pay in mortgage payments every month and several factors come into play.
If a lower mortgage payment is what you're after, consider gathering a larger down payment in an effort to not only reduce the overall amount that you have to borrow, but also to avoid having to pay extra in PMI premiums every month. In addition, a lower loan value will also help you get approved for a mortgage at a lower interest rate, which can further reduce your mortgage payments.