What goes into a mortgage payment

Lenders call the full payment PITI — principal, interest, taxes and insurance. Principal and interest are the loan itself; taxes and insurance are usually collected monthly into an escrow account and paid on your behalf. Add HOA dues and mortgage insurance where they apply, and you have the number that actually leaves your account.

How the payment is calculated

The principal-and-interest portion uses the standard amortised loan formula: M = P × r(1+r)ⁿ / ((1+r)ⁿ − 1), where P is the loan amount, r is the monthly interest rate and n is the number of payments. On a $360,000 loan at 6.5% over 30 years that gives $2,275.44 a month. Because the rate is applied to the outstanding balance each month, early payments are mostly interest — a fact the amortisation schedule makes uncomfortably clear.

When mortgage insurance applies

If your loan is more than 80% of the home's value, most conventional lenders require private mortgage insurance. It protects the lender, not you. Rates commonly run 0.3%–1.5% of the loan per year depending on credit score and down payment. It is not permanent: once the balance reaches 78% of the original value it generally cancels automatically, and you can usually request cancellation at 80%. This calculator applies PMI only when LTV exceeds 80%, which is why increasing your down payment past 20% makes the PMI line disappear entirely.

The 28/36 rule explained

The two ratios lenders use are usually written as 28/36. The front-end ratio says your total housing cost — payment, taxes, insurance, HOA — should not exceed 28% of gross monthly income. The back-end ratio says all your debt payments together, including car loans, student loans and minimum credit card payments, should not exceed 36%.

Whichever limit binds first is your real ceiling, and this calculator tells you which one it was. That matters, because the fix is different: if the front-end ratio limits you, a larger down payment or a cheaper house helps. If the back-end ratio limits you, paying off a car loan may raise your budget more than saving another $10,000 of deposit.

Why lenders may approve you for more

Many lenders will go above 36% — sometimes to 43% or beyond for well-qualified borrowers, and government-backed programmes often allow more. Being approved for a number is not the same as that number being wise. The 28/36 guideline exists because it leaves room for the costs that do not appear on a loan application: maintenance, repairs, rising insurance premiums and the reality that a house consumes money in ways a rental does not.

Why early payments are almost all interest

Interest is charged on the outstanding balance, and at the start the balance is at its maximum. On a $360,000 loan at 6.5%, the first month's interest is $1,950 out of a $2,275 payment — only $325 reduces the debt. It takes roughly eighteen years before the principal portion of each payment overtakes the interest portion.

This is also why extra payments are so effective early on and much less so later. Every extra dollar paid in year one removes a dollar of balance that would otherwise have accrued interest for twenty-nine more years. The same dollar in year twenty-five saves comparatively little.

The arithmetic of paying extra

Adding a modest amount each month shortens the term more than most people expect, because the saving compounds. Try $200 a month in the calculator above and watch both the payoff date and the total interest move. The one caveat: confirm your lender applies extra payments to principal rather than holding them as a prepaid instalment, and check for prepayment penalties, which still exist on some loans.

The four numbers that matter

Net operating income (NOI) is rent minus vacancy minus operating expenses, before any mortgage payment. It describes the property, not your deal. Cash flow is NOI minus debt service — what actually lands in your account. Cash-on-cash return divides annual cash flow by the cash you invested, which is the honest measure of your return. DSCR divides NOI by annual debt service; lenders typically want at least 1.20, and anything under 1.0 means the property cannot cover its own mortgage.

What counts as an operating expense

Property tax, insurance, management, maintenance, repairs, landscaping, utilities you pay, and capital reserves for the roof and mechanicals that will eventually need replacing. Mortgage payments are not operating expenses — that is the distinction that keeps NOI comparable between a cash buyer and a leveraged one. Many first-time analyses come out optimistic simply because capital reserves were left out.

What cap rate actually tells you

Capitalisation rate is net operating income divided by price. A property producing $16,000 of NOI priced at $250,000 has a 6.4% cap rate. Because it excludes financing, two buyers of the same property at the same price always compute the same cap rate — which is precisely what makes it useful for comparing buildings and useless for judging your personal return.

Reading the number in context

A low cap rate is not automatically bad. Expensive, stable markets trade at 3–5% because buyers accept lower income in exchange for appreciation and lower risk. High cap rates of 9–12% usually appear in markets with weaker demand, older stock or higher management burden. The cap rate is partly a risk premium, so a property whose cap rate looks unusually generous for its area is telling you something — find out what.

Gross rent multiplier

GRM is price divided by annual gross rent, and it is the quick-and-dirty cousin of cap rate. It skips expenses entirely, which makes it fast for screening a list of properties and unsuitable for a decision. Two buildings with identical GRMs can have very different NOI if one has old mechanicals and the other was just renovated.

Where the 30% goes

The 70% rule says: offer no more than 70% of after-repair value, minus repairs. On a $300,000 ARV with $45,000 of work, that caps your offer at $165,000. People often assume the missing 30% is pure profit. It is not. It has to absorb buying closing costs, months of holding costs, selling costs of 6–8% including agent commission, and only then profit.

Run the numbers above and you will see roughly $34,500 of that gap consumed by costs before a dollar of profit appears. That is why the rule is 70% and not 85% — and why experienced flippers tighten it to 65% in slower markets or when repair estimates are uncertain.

The two numbers that sink flips

Repair estimates are optimistic almost by default, and the overrun tends to be discovered after demolition when backing out is expensive. Holding time is the other: every extra month costs mortgage interest, taxes, insurance and utilities on a property producing no income. A flip that takes ten months instead of six on $1,200 of monthly carry loses $4,800 of profit without anything having gone visibly wrong.

Closing costs usually run 2–5% of the price

Buyers routinely save a down payment and then discover they need several thousand more at signing. On a $400,000 purchase, closing costs of 2–5% mean $8,000 to $20,000 on top of the deposit. Some are lender fees, some are third-party services, and some are simply prepaid amounts for taxes and insurance that you would have paid anyway — just sooner than expected.

What is negotiable

Origination and lender fees vary between lenders and are worth comparing directly; the Loan Estimate document exists precisely so you can put offers side by side. Title insurance is sometimes shoppable depending on jurisdiction. Recording and transfer taxes are set by government and are not negotiable. In some markets sellers contribute towards buyer closing costs as part of the deal — always worth asking, particularly in a slower market.

Why the usual comparison is wrong

Comparing rent to a mortgage payment is comparing a complete cost to a partial one. Owning adds property tax, insurance, maintenance, closing costs at purchase and selling costs at exit. Meanwhile the renter has capital that the buyer has tied up in a deposit — capital that could be earning a return elsewhere. A comparison that ignores either side is not a comparison.

This model tracks both. On the buying side it accumulates interest, tax, insurance, HOA, PMI and maintenance as costs, and credits you with the equity you hold at the end, net of selling costs. On the renting side it accumulates rent (growing each year) and credits the renter with a portfolio built from the down payment, the closing costs they never paid, and any monthly difference where owning costs more.

The variable that decides it

Time. Buying carries large one-off costs at both ends — closing costs going in, agent commission and transfer costs coming out. Spread over twenty years those are trivial; spread over three years they can easily exceed everything appreciation earned. This is why the conventional advice to avoid buying if you might move within a few years is usually sound, and the calculator will show you where your own break-even sits.

Equity comes from two directions

Your equity is the property's value minus what you still owe, so it grows from both ends: the balance falls as you pay down principal, and the value rises (usually) with the market. In the early years appreciation does far more work than paydown, because so little of each payment reduces the balance. Later the two swap places.

Appreciation is also the leveraged part. If you put $80,000 down on a $400,000 house and it gains 3%, that is $12,000 of value on $80,000 of your own money — a 15% return on your cash, before costs. Leverage works identically in reverse, which is what makes a highly-mortgaged property in a falling market uncomfortable.

Treat the appreciation figure with suspicion

Long-run housing appreciation has historically been modest in real terms — often close to inflation, with long flat stretches and occasional sharp falls. A projection at 3% a year is a planning assumption, not a promise, and small changes to it compound into large differences by year fifteen. Run the calculator at 1% and at 5% and treat the gap between them as the honest range.

Using price per square foot properly

Price per square foot is the fastest way to sanity-check a price, and the easiest to misuse. It works when comparables are genuinely comparable — similar size, age, condition, lot and location. It breaks down quickly otherwise, because the relationship is not linear: smaller homes almost always carry a higher price per square foot than larger ones, since kitchens, bathrooms and mechanical systems cost roughly the same regardless of the floor area wrapped around them.

What the spread tells you

If your comparables cluster tightly, the market is telling you a clear number. If they range from $180 to $260 per square foot, either the properties are not really comparable or the market is genuinely uncertain — and a valuation drawn from the average alone is hiding that. The standard deviation shown above is a quick measure of how much to trust the average.

Who owes what on closing day

Property taxes, HOA dues and similar annual charges rarely align with the closing date. Proration divides them by the days each party owns the property. If taxes are $3,650 a year — a convenient $10 a day — and closing falls on day 100, the seller is responsible for 100 days ($1,000) and the buyer for the remaining 265 ($2,650).

How this appears on the settlement statement depends on whether the bill has already been paid. If the seller paid the full year in advance, the buyer reimburses them for the unused portion. If the bill is still outstanding and the buyer will pay it, the seller credits the buyer for their share. Same arithmetic, opposite direction — and getting the direction wrong is a common source of confusion at the table.

Actual days or banker's year

Most jurisdictions prorate on actual days (365, or 366 in a leap year), but some contracts and some regions still use a 360-day "banker's year" of twelve 30-day months. On a $3,650 bill the difference is small; on a large commercial tax bill it is worth checking which convention your contract specifies.

1. Mortgage mechanics

An amortised mortgage is a loan repaid in equal instalments, where each payment covers the interest accrued that month and applies the remainder to the balance. The payment is fixed but its composition shifts continuously — heavily interest at the start, heavily principal at the end.

Worked example. $360,000 at 6.5% over 30 years gives a payment of $2,275.44. Month one: interest is $360,000 × 0.065 ÷ 12 = $1,950.00, so only $325.44 reduces the balance. By month 240 the same $2,275.44 payment is roughly half principal. Across the full term you pay about $459,000 in interest — more than the loan itself, which is why rate and term matter enormously.

Rate versus term

Shortening the term raises the payment but slashes total interest. The same $360,000 at 6.5% over 15 years costs about $3,136 a month — 38% more — but total interest falls from roughly $459,000 to around $205,000. Whether that trade is right depends on what else the money could do and how secure the higher payment is.

2. What you can afford

The 28/36 rule caps housing at 28% of gross monthly income and total debts at 36%. On $96,000 a year that is $2,240 for housing, or $2,380 minus existing debts for the back-end test. With $500 of car and card payments the back-end limit is $1,880 — so debts, not income, are the binding constraint, and paying off the car raises the housing budget more than saving another deposit would.

Remember these ratios use gross income. After tax, a payment at 28% of gross may be 35–40% of what actually reaches your account.

3. Rental property metrics

Worked example. A $250,000 duplex renting for $2,200 a month. Gross annual rent $26,400. Allow 5% vacancy: $25,080 effective. Operating expenses at 35%: $8,778. NOI = $16,302. Cap rate = 16,302 ÷ 250,000 = 6.52%.

Now finance it: $50,000 down at 7% over 30 years on the $200,000 balance is $1,330.61 a month, or $15,967 a year. Cash flow = 16,302 − 15,967 = $335 a year. With $60,000 invested (down payment plus $6,000 closing plus $4,000 repairs), cash-on-cash is 0.56%. DSCR is 1.02 — the property barely covers its own debt, and most lenders want 1.20.

That is a deal which looks acceptable on cap rate and is marginal in reality. The gap between those two impressions is the entire reason to run both numbers.

4. Flipping and the 70% rule

Maximum offer = ARV × 70% − repairs. On a $300,000 ARV needing $45,000 of work: $210,000 − $45,000 = $165,000. Buy at that price and the costs are roughly: $3,300 buying closing (2%), $7,200 holding (6 months at $1,200), $24,000 selling costs (8%). Total outlay $244,500 against a $300,000 sale — about $55,500 profit, or 22.7% on cost.

Push the purchase to $185,000 and profit falls to roughly $35,100. Add two months of unexpected holding and it drops another $2,400. The rule's margin is not generosity; it is the buffer that keeps ordinary surprises from turning a project into a loss.

5. Costs at closing

Expect 2–5% of the purchase price. On $400,000 with 20% down, a typical build-up is: origination $3,200 (1% of the $320,000 loan), title and search $2,000, recording and transfer $1,600, prepaid taxes and insurance about $3,800, appraisal $500 and inspection $450 — roughly $11,550, or 2.9%. Add the $80,000 deposit and the cash needed at signing is $91,550.

6. Rent versus buy

The comparison only works if both sides are complete. Buying costs interest, tax, insurance, maintenance, closing and selling costs, and returns equity. Renting costs rent, and returns whatever the un-spent deposit earned invested. Over long horizons ownership usually wins because the one-off transaction costs amortise and rent keeps rising. Over short horizons renting usually wins because those same one-off costs dominate.

There is no universal answer, and anyone who gives you one without asking how long you plan to stay is not doing the maths.

7. Common mistakes

• Treating cap rate as your return. It deliberately ignores your mortgage.
• Omitting vacancy and capital reserves. Roofs and boilers fail on their own schedule, not yours.
• Confusing pre-approval with affordability. Lenders lend against risk of default, not against a comfortable life.
• Applying PMI for the whole loan term. It stops at 80% LTV, and modelling it forever badly distorts lifetime cost.
• Comparing rent to a mortgage payment. Compare total cost of ownership to total cost of renting, or do not compare at all.
• Trusting a single comparable. One sale is an anecdote; the spread across several is the information.

None of this is financial advice, and none of it substitutes for a local agent, lender, accountant or attorney who can see your actual situation and jurisdiction.