Future Value Formula: Calculations and Examples for Investments

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Mortgage payment calculator

 
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future home value calculation for buyers

There are several factors that determine mortgage payments.

These include:

  1. Loan Amount: The principal amount borrowed to purchase the property.
  2. Interest Rate: The annual interest rate charged by the lender on the loan.
  3. Loan Term: The length of time over which the loan will be repaid (e.g., 15, 20, or 30 years).
  4. Payment Frequency: How often payments are made (e.g., monthly, bi-weekly, or weekly).
  5. Amortization Period: The total length of time it will take to pay off the mortgage in full, including both the loan term and any additional time required to pay off any remaining balance.
  6. Down Payment: The initial money paid  towards the purchase price of the home. The mortgage payments can be lowered by paying a larger amount as a downpayment
  7. Taxes and Insurance: Property taxes and homeowners insurance may be included in the mortgage payment through an escrow account, increasing the total monthly payment.
  8. Type of Mortgage: Fixed-rate mortgages have consistent payments over the term, while adjustable-rate mortgages may have varying payments based on changes in interest rates.
  9. Prepayment: If you pay any extra money towards the principal, then it will shorten your mortgage payment period and also reduce your monthly payments.
  10. Mortgage Insurance: If the buyer is putting in less than 20% of the purchase price, then mortgage insurance may be required by the lender, which adds to the monthly payment.

The above-mentioned factors interact to determine the total amount of the mortgage payment, which typically includes both principal and interest. It is important to consider all these factors when calculating mortgage payments and to choose a mortgage option that matches your financial situation and long-term goals.

Future Value Calculation Formula

We can calculate the future value (FV) of an investment or asset using the future value formula. This formula takes into account factors such as the initial investment (present value), interest rate, compounding frequency, and period. The formula for calculating the future value of an investment with compound interest is:

FV=PV(1+i)n

Where:

FV = Future Value
PV  = Present Value (initial investment or principal)
r = Interest Rate per period (expressed as a decimal)
n = Number of periods (time)

If the interest is compounded annually, then n  would represent the number of years. If the interest is compounded quarterly, monthly, or daily, then n  would represent the number of compounding periods per year multiplied by the number of years.

For example, let’s assume you invest $10,000 at an annual interest rate of 5% compounded annually for 5 years. Using the future value formula:

FV = $10,000 \times (1 + 0.05)^5

FV = $10,000 \times (1.05)^5

FV = $10,000 \times 1.2762815625

FV = $12,762.82

In the above example, the future value of the investment after 5 years would be approximately $12,762.82.

Please note that if the interest is compounded more frequently within a year (e.g., quarterly, monthly), you would have to adjust the formula accordingly by dividing the annual interest rate by the number of compounding periods per year and multiplying the number of years by the total number of compounding periods.

Mortgage payments have a significant impact on a buyer’s purchasing power, which is the maximum amount they can afford to spend on a home. Here are the key factors and how they influence purchasing power:

1. Monthly Payment Affordability

Income and Debt-to-Income (DTI) Ratio:

  • Lenders typically look at a buyer’s debt-to-income ratio to determine how much of their income can go toward mortgage payments.
  • DTI ratio is calculated by dividing total monthly debt payments by gross monthly income.
  • A common maximum DTI ratio allowed by lenders is around 43%, but lower ratios (e.g., 36%) are often preferred.

Example:

  • If a buyer earns $5,000 per month and the lender allows a DTI ratio of 36%, the maximum monthly debt payments allowed would be $1,800.
  • If the buyer has other debt payments totaling $500 per month, the maximum mortgage payment they can afford would be $1,300.

2. Interest Rates

Impact on Monthly Payments:

  • Interest rates directly affect the size of monthly mortgage payments.
  • Lower interest rates reduce monthly payments, increasing purchasing power.
  • Higher interest rates increase monthly payments, reducing purchasing power.

Example:

  • For a $300,000 loan at a 4% interest rate over 30 years, the monthly payment is approximately $1,432.
  • For the same loan at a 5% interest rate, the monthly payment is approximately $1,610.

3. Loan Term

Impact on Monthly Payments:

  • The length of the mortgage term (e.g., 15-year vs. 30-year) affects monthly payments.
  • Shorter loan terms have higher monthly payments but lower total interest paid over the life of the loan.
  • Longer loan terms have lower monthly payments but higher total interest paid.

Example:

  • A $300,000 loan at 4% for 30 years has a monthly payment of about $1,432.
  • The same loan for 15 years has a monthly payment of about $2,219.

4. Down Payment

Impact on Loan Amount:

  • A higher down payment reduces the loan amount needed, which in turn reduces monthly mortgage payments.
  • A lower down payment increases the loan amount needed, increasing monthly mortgage payments.

Example:

  • A 20% down payment on a $400,000 home is $80,000, requiring a $320,000 loan.
  • A 10% down payment on the same home is $40,000, requiring a $360,000 loan.

5. Property Taxes and Insurance

Impact on Monthly Housing Costs:

  • Property taxes and homeowners insurance add to the monthly housing costs.
  • Higher property taxes or insurance premiums reduce purchasing power by increasing total monthly housing costs.

Example:

  • If property taxes are $6,000 annually and insurance is $1,200 annually, the combined monthly cost is $600.
  • These costs must be included in the DTI calculation, reducing the amount available for the mortgage payment.

Overall Effect on Purchasing Power

Calculating Maximum Purchase Price:

  • Lenders use the maximum affordable monthly payment to calculate the maximum loan amount.
  • The total purchasing power is the maximum loan amount plus the down payment.

Example Calculation:

  1. Maximum affordable monthly mortgage payment: $1,300
  2. Assume 30-year fixed-rate mortgage at 4% interest:
    • Using a mortgage calculator or formula, the maximum loan amount for $1,300/month is approximately $272,000.
  3. If the buyer has $50,000 for a down payment:
    • Total purchasing power = $272,000 (loan) + $50,000 (down payment) = $322,000

In summary, mortgage payments influence a buyer’s purchasing power by determining the maximum loan they can afford based on their income, debt, interest rates, loan term, down payment, and additional housing costs. Lower monthly payments increase purchasing power, allowing buyers to afford more expensive homes, while higher payments decrease purchasing power.

 
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