Mortgage payment shock can impact both loan approval and your budget. Realistic budgeting, smart loan choices, and cash reserves—along with a supportive lender—help minimize shock and secure suitable financing.
Adam Godby (NMLS #2286643) is a Loan Officer and Team Lead at Paddio Home Loans (NMLS #1907), a Springfield, Missouri-based national lender. Equal Housing Opportunity. Paddio Home Loans is a registered DBA of Mortgage Research Center, LLC, an affiliate of Three Creeks Media.
You know that feeling in your gut when you see the menu prices at a super nice restaurant?
That feeling, of course, is called sticker shock. I have felt it in car repair places and jewelry stores, too.
Mortgage payment shock is the home buying version of this. But, unlike sticker shock, mortgage payment shock might extend beyond that initial feeling.
Mortgage payment shock is a metric lenders track. That means it could hurt, or help, your mortgage loan approval.
What Is Mortgage Payment Shock?
I’ll be honest. As a loan officer, mortgage payment shock isn’t the first thing on my mind when someone applies for a new mortgage loan.
At first, I’m thinking a lot more about their down payment requirement, their loan type, their credit history, and whether they can document enough income to get the loan.
All those variables, along with the home’s purchase price, have to fall into place in order to get an estimated monthly payment for the loan.
If that new proposed monthly payment, as shown on the Loan Estimate, is a lot different than what the buyer pays for housing right now? That’s when mortgage payment shock exists and can become a factor.
By definition, mortgage payment shock exists when the new loan’s payment will be either 5 percent higher or $100 higher than the buyer’s current house payment, whichever number is less.
What is the Threshold for Mortgage Payment Shock?
By definition, mortgage payment shock exists when the new loan’s payment will be either 5 percent higher or $100 higher than the buyer’s current house payment, whichever number is less.
Let’s run some numbers to show how this works:
We’ll say I have a client who is paying $1,200 in rent right now.
5 percent more than $1,200 is $1,260.
$100 more than $1,200 is, of course, $1,300.
Since the lesser of these two numbers qualifies as mortgage payment shock, the new loan’s estimated payment would have to come in below $1,260 to eliminate payment shock from consideration.
So does that mean the lender wouldn’t approve a loan with payments higher than $1,260 a month? Absolutely not. It just means payment shockcan become a factor in loan approval.
What Causes Mortgage Payment Shock?
Mortgage payment shock is usually caused by unusually low rents. Maybe you live rent-free in a relative or friend’s basement? Or maybe you rent a room in a boarding house for a few hundred dollars a month?
If you pay only $300 in rent, for instance, you’re pretty much guaranteed to experience mortgage payment shock when you apply for your own 30-year mortgage on a home.
Likewise, home buyers moving from a low-cost housing state like New Mexico or Kentucky to a high-cost market like Seattle or the Bay Area will almost always experience payment shock.
Once again, payment shock won’t sink your loan application all by itself. If you’re looking at a proposed monthly payment on a Loan Estimate, your lender most likely thinks you can afford that payment, even if it’s 50 percent more than your current rent.
When Payment Shock Impacts Loan Approval
Payment shock can become a factor when a loan file is already shaky.
Here’s what I mean: To measure how much you can afford to pay each month on a mortgage loan, I’d check your DTI which stands for debt-to-income ratio. This ratio compares your gross monthly income to your monthly debts. It shows how much room you should have in your budget for housing.
Different loan types set different DTI limits, but for this example we’ll say your DTI max is 45 percent. So if you make $10,000 per month, just to use a round number, all your current monthly debt payments, including your new house payment, can’t total more than $4,500.
For this example, we’ll say you’re pushing that DTI limit to the max:
Your new house payment barely fits within your DTI threshold. This leaves little room for error in your monthly budget.
On top of that, you’re making only the minimum down payment of 3.5 percent on your FHA loan.
And making that down payment, plus paying your loan’s closing costs, will zap your savings account, leaving no cash reserves.
All in all, you’re on shaky ground, but your loan hasn’t broken any rules.
Enter Mortgage Payment Shock
Your lender is not thrilled with the scenario above, but the loan is still within acceptable parameters. It’s still on track. But then it comes to light that your new payment of $2,000 a month is $800 more than your current $1,200 in rent.
Mortgage payment shock now enters the equation. Not only does your loan push the limits of eligibility, but it’ll also require immediate sacrifice for you and your family. You’ll have to spend $800 less on other monthly expenses to keep the house payment current.
In this case, mortgage payment shock could tip the balance, pushing your loan outside of guidelines.
What About the Opposite of Payment Shock?
The opposite of payment shock can and does happen. We call this negative payment shock. It doesn’t happen often, but lenders love seeing this when it does.
For example, if you’re accustomed to paying $2,000 a month but your new loan will cost only $1,500 a month, that’s a strengthening factor for your loan approval.
This could tip a loan file back in the right direction and allow for approval even if it’s on shaky ground.
How to Keep Mortgage Payment Shock in Check
Anything that raises a loan’s monthly payment can increase mortgage payment shock. To keep payment shock at a minimum, home buyers can:
Make a bigger down payment
People who make larger down payments pay less each month for the same home. They pay less because the bigger down payment allows them to borrow less money.
How can you afford a bigger down payment? Some borrowers ask family and friends to help. Or they ask the seller to help with closing costs, freeing up more cash to put down.
Buy in lower cost areas
Homes with big annual property tax bills, expensive homeowners insurance premiums, and HOA fees, require higher monthly payments. HOAs are homeowners associations. They pay for community property like neighborhood swimming pools and tennis courts.
Home buyers can keep payments lower by shopping around for cheaper insurance, staying out of neighborhoods that have HOAs, and finding communities with lower property tax rates. Realtors can help locate these kinds of properties.
Use the right type of loan
Most FHA borrowers pay a 0.55 percent annual fee for mortgage insurance, equalling about $46 per month per $100,000 borrowed.
But conventional loans often charge a lot more in private mortgage insurance (PMI), especially when borrowers don’t have perfect credit and a large down payment. Borrowers should use the loan that best fits their financial profile. For first-time buyers with low down payments, that’s often an FHA loan.
Get the right loan term
Shorter loan terms, like 12- and 15-year fixed, can save a lot on interest over the life of the loan, but they cost a lot more each month in the meantime. A standard 30-year fixed loan requires lower payments and creates less payment shock.
Buyers who use 30-year loans can still pay extra on the loan’s principal to lower long-term interest.
Buy a cheaper house
This is especially true for first-time buyers: You don't have to buy your dream home right away. Buy a cheaper home that’s nice enough to live in for a few years. This is a great way to secure a payment you can afford.
Then, in a few years, you can leverage the equity you’ve built to buy a nicer home, if you still want to.
For one client, I estimated $2,000 a year in homeowners insurance, which seemed reasonable. But the insurance policy came in at $3,200 a year. That added another $100 a month to the house payment which, all by itself, is enough to qualify as mortgage payment shock.
A Real-Life Example of Payment Shock
When my clients experience mortgage payment shock, it usually comes from expenses other than the loan’s principal and interest payment.
Repaying principal and interest is the foundation of a mortgage payment, but each payment also includes money for property taxes and homeowners insurance.
As lenders, we can’t know for sure how much these extra charges will cost. We can only estimate based on past history. I like to overestimate these fees. This helps avoid surprises later.
Even so, I’ve had some buyers experience payment shock because of how much these fees cost in reality.
For one client, I estimated $2,000 a year in homeowners insurance, which seemed reasonable. But the insurance policy came in at $3,200 a year. That added another $100 a month to the house payment which, all by itself, is enough to qualify as mortgage payment shock.
In this case, it turned out the client’s spouse had gotten a few speeding tickets which was a factor in the cost of the new homeowners coverage. I had no way of knowing that.
How to Prepare for Payment Shock
As a loan officer, I know a lot about a client’s finances by closing day. I have to learn this. Federal law requires lenders to find out whether the borrower can afford the home’s monthly mortgage payments. This protects the lender and the borrower.
But numbers don’t show everything. The data shows what should be true about the borrower’s finances. Ultimately, it’s up to buyers to be honest with themselves about their monthly spending and about what they’re capable of paying for housing each month.
Tips to Prepare for a Higher Mortgage Payment
Budgeting is key. It may seem boring and obvious, but making and following an honest budget will help buyers prepare for a bigger mortgage payment, taking the bite out of mortgage payment shock.
Specifically, would-be buyers should:
Track spending: What you think you’re spending and what you’re really spending may be two different numbers. For example, all those $10 to $20 streaming services turn into $100 or $120 a month when added together. Budgeting apps can help with this, but pencil and paper can work, too.
Save up a reserve fund: Unexpected expenses can sink a family budget that’s already on the edge. Saving up and keeping a reserve fund removes a lot of stress, and it can stop mortgage payment shock from becoming a factor in your loan’s approval.
Practice making a larger payment: If your rent is $1,200, try out paying $2,000 a month instead. Put the extra $800 in savings. This provides some practice on a bigger payment while also building a reserve fund. Can’t do an extra $800? Pick a figure you can sustain.
Remember, the money spent on mortgage payments goes toward owning an asset that should make your financial future more stable. It’s worth some sustainable sacrifice along the way.
What to Do If You’re Facing Mortgage Payment Shock
For most people, buying a house costs more than renting at first. There’s an upfront buy-in which includes the down payment and the closing costs. The monthly payments may be higher, too.
This buy-in pays off over time. As rents keep going up, the mortgage payment stays about the same. In fact, the principal and interest payments do stay the same. Any payment increases come from property tax or homeowners insurance premiums.
Within five to 10 years, a mortgage payment that seems so expensive now may seem like a steal compared to market rents at that time.
But it takes a while to get to that point, and this rosy future won’t help someone whose mortgage payment is causing pain and putting them at risk of defaulting on the loan.
If you’re in over your head, consider:
Refinancing: You may be able to get a lower payment through refinancing into a new mortgage that better fits your life. There will be more closing costs to consider.
Asking for help: Ask your loan servicer for a loan modification or a payment relief program. Ask before falling behind on the payments.
Renting the home: Can you rent out part of the home for extra income? Or can you rent the entire home and live with family for a year while you regroup?
I recommend talking to a financial advisor to get other ideas. Hanging onto the home so you can benefit from all the money you’ve invested so far is a worthy goal.
Mortgage Payment Shock: Relief Is Possible
If you’ve read this far you know that mortgage payment shock is really two things:
The general anxiety that comes from adjusting to a higher house payment
A measurable factor that could help decide whether you get mortgage approved
Whether you’re facing one or both of these obstacles, a mortgage loan that matches the reality of your financial life can be the answer.
The best way to achieve this goal: Working with a lender who wants what’s best for you.
