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Financing

Mortgage Math Made Simple

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What's more terrifying than global warming, national economic collapse, or a zombie apocalypse? For many of us, it's math -- especially the type involved in securing a mortgage to buy a home.

But mortgage math doesn't have to be intimidating. Though a home loan does indeed involve a few equations, it's fairly easy to break it all down into the kind of simple arithmetic every home buyer can understand and, more important, needs to know.

Take note: The latest figures available show the median home costs about $220,000, so we'll use that figure as a base for our calculations. Other figures we'll use: an average family's annual salary is about $54,000 and it carries $7,630 in debt.

How much do you need for a down payment?

Though you can contribute as little as 3.5% of a home's value for a down payment, lenders consider an ideal down payment to be 20% of a home's total price. So here's the math on that for the average-priced home:

20% of $220,000 = $44,000 down payment

This would leave $176,000 -- the amount a home buyer will need for the mortgage.

Another reason to aim for 20% down: You'll avoid paying private mortgage insurance, which is typically required under that threshold. And that will cost you about $1,000 per year, says David Bakke of Money Crashers.

(Still, if that hefty 20% is an unattainable goal, at least try to put down 10% for a significantly better interest rate than you'd get with 3.5%.)

How much will a mortgage cost per month?

A mortgage can be paid off in numerous ways, but one of the most typical is to stretch those payments out over 30 years -- that way, you break it down into bite-size pieces. Building off the numbers above, here's how much your average mortgage would cost per month:

$176,000 at 4% interest rate = $840.25 monthly payment

Keep in mind, this monthly bill does not include property taxes, home insurance, HOA dues, or other home-related maintenance fees, which vary by area but are in the ballpark of a few hundred per year for a home at this price.

Also note that the longer you stretch out your mortgage payments, the more you'll end up paying in interest. Over 30 years, the total you'll fork over in interest amounts to $302,490.33!

But there are ways to lower the amount you pay in interest -- like paying off your loan faster. Finish in 15 years, and you'll end up paying only $234,333.13 in interest. Granted, for a 15-year loan you'll have to cough up more per month -- $1,301.85 instead of $840.25. But the upside is you'll save a sizable chunk in interest over the life of your loan, and be mortgage-free in half the time. So if you can afford it, it's an option worth considering.

How much mortgage can I afford?

Of course, you'll want to buy a home that you can comfortably pay for. So, how do you know how much is too much, too little, or just right? The way they do this is by determining your debt-to-income ratio.

For most conventional loans, experts say you'll want your DTI ratio lower than 36%. That means your debts don't exceed more than about one-third of your income. But how does a mortgage fit into that?

To figure that out, start with your gross income (what you take home before taxes). Let's say your family pulls in the U.S. average, which is $54,000 per year. Divide that over 12 months to get your monthly income.

$54,000 / 12 months = $4,500 income per month

Then total up your debts -- including what you owe on credit cards, auto insurance, and college loans. Remember, debt includes only items that appear on a credit report, not recurring expenses like groceries or phone bills. Since the average American carries an average debt of $7,630 per year, we'll use that number. Divide that by 12 to get your monthly debt:

$7,630 (average debt) / 12 months = $636 debt per month

Now, add that monthly debt to your average monthly mortgage payment of $840.25 to get your total debt owed per month:

$636 debt + $840.25 mortgage = $1,476.25 debt per month

Next, divide your monthly debts by your monthly income

$1,476.25 monthly debt / $4,500 monthly income = 33% DTI

In this scenario, the debt-to-income ratio is 33% -- just below the 36% cutoff. Which means this mortgage would most likely pass the bank's muster with flying colors! Calculate your own DTI here.

See? Not so hard. Granted, this is a simplified version of mortgage math; your own results will depend on your income, debts, and other circumstances. But if there's one thing we hope you take away from this, it's that mortgages are nothing to fear -- a little knowledge goes a long way. And if you get stuck, there's no need to copy from your neighbor's paper, since we have this handy mortgage calculator to help you whiz through these permutations with ease.

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Watch: What Your Mortgage Broker Wishes You Knew