What is a mortgage?
A mortgage is a loan used to buy a house. The house then acts as collateral for the loan, so if the homeowner does not make their monthly payments, the lender can seize the house. There are several different types of mortgage programs and ways to compare those mortgages. Picking the best type of mortgage for you can mean a difference of tens of thousands of dollars over the life of the loan. When you take out a mortgage, you usually have to make a down payment to the lender. The minimum down payment varies depending on the mortgage type but usually ranges between 3% and 5%. If you put down less than 20%, you often have to pay a special fee, known as private mortgage insurance (PMI), and you may be charged a higher interest rate. Some mortgages do not require a down payment, but these usually have special requirements.What does a mortgage payment include?
Principal and Interest
The principal is the home’s cost minus any down payment. When you take out a mortgage, you will be charged interest. The monthly payment will be divided between principal and interest. The amount that goes toward the principal and interest will vary. Most mortgage loans are set up so that the bulk of your initial payments go toward interest, not principal. However, toward the end of the loan term, the majority of the payments will go toward paying down the principal, not the interest.Property Taxes
A municipality charges property taxes based on the assessed value of your home. Your assessed value may change over time, usually increasing, which means your property taxes may also increase. A city or county may have its own property tax rates, which often vary from location to location. Property taxes may not necessarily come out of your monthly mortgage payment.Private Mortgage Insurance (PMI)
If you put down less than 20% on a mortgage, you usually have to pay a mortgage insurance premium. This will cover the lender in case you default on the home while you have less than 20% equity. The cost of mortgage insurance depends on your down payment and the mortgage program. Once you reach 20% equity, you may be able to remove mortgage insurance premiums from your monthly payment. Sometimes, you may have to refinance the mortgage to remove this mortgage insurance.Homeowners Insurance
Homeowners insurance covers damage that occurs to your property, like a fire, storm, and more. Flood damage may or may not be covered depending on your specific policy. The cost of the homeowner's insurance premium depends on your home’s value, deductible, and coverage level. If you opt for a lower deductible, your premium will usually be higher - and vice versa. Your insurance payment will be bundled in with your monthly mortgage payment.Mortgage Terminology
Adjustable-rate mortgage
An adjustable-rate mortgage starts with one interest rate, usually a relatively lower one, and then shifts to a different interest rate after a predetermined period of time. If rates have gone up since you initially took out the mortgage, then your new rate may be significantly higher. An adjustable-rate mortgage may offer lower monthly payments than a fixed-rate mortgage in the short term but can cost much more in the long term. If you only plan on living at a property for a few years, an adjustable-rate mortgage might make financial sense.Appraisal
The appraisal is the home’s value, determined by an official, impartial appraiser. The lender will use the appraisal value to determine the maximum loan amount. If the offered price exceeds the appraisal, the buyer must decide whether to pay the difference in cash or negotiate a lower sales price.Earnest money
When you make an offer, you usually have to put a deposit down to show that you’re serious. This is known as earnest money, which normally costs between 1% and 3% of the purchase price. If you back out of the sale for an inexcusable reason, you will lose the earnest money.Fixed-rate mortgage
Most mortgages have fixed interest rates, which means that the interest rate will not change over the life of the loan unless you refinance. The monthly payment may still vary under a fixed-rate mortgage, but this will be due to fluctuations in property taxes or homeowners insurance - not due to the interest rate. You may be able to refinance a fixed-rate mortgage for a lower rate later on.Inspection
An inspector will thoroughly look over the home to determine if there are any major issues. While an inspection is often optional, you should never skip it. It’s common to uncover huge problems during an inspection that can’t be seen during an open house. Information from the inspection can potentially be used to negotiate a reduction in the sale price or repairs with the seller.Repayment term
The repayment term on a mortgage is how long it will take to pay off the balance. Mortgage terms can range from 10 to 50 years, but the availability depends on your lender. Most borrowers typically choose a 15- or 30-year mortgage.Home-buying basics:
Buying a home is a multifaceted process. Here are some basic steps to follow:- Figure out your credit score: You typically need a credit score of 620 or higher to qualify for most types of mortgages. If your score is below that threshold, work on improving it before applying for a home loan. Your credit score will also affect the interest rate, so try to raise it as much as possible.
- Figure out how much you can afford: You should determine how much you can afford to pay each month. Don’t forget to set aside money for home repairs, moving costs, and other expenses. Once you know your maximum monthly payment, you can determine your overall mortgage limit.
- Determine your mortgage program eligibility: Some borrowers may qualify for multiple types of mortgages. Compare and contrast these programs to determine which type of loan fits you best.
- Save for a down payment: Unless you plan to use a VA or USDA loan, you’ll need to make a down payment on the mortgage.
- Start looking around: While saving for a down payment, you can start looking at various properties and determining what matters most to you in a potential home.
- Get a real estate agent: Most borrowers find the home-buying process is easier with a qualified and reputable real estate agent. Get recommendations from local friends and family. Don’t be afraid to interview multiple agents to find the best match for you.
The pre-approval process
Before you start visiting open houses, try to get pre-approved for a mortgage. Unlike pre-qualification, pre-approval requires that the lender verify your financial information, including your credit score and debt-to-income ratio, instead of relying only on the borrower’s self-reporting. If you are pre-approved, you are much more likely to have your offer selected by a seller. It means that a lender has reviewed your finances and can vouch that you can afford a mortgage at a certain price point. It also gives you an idea of the current interest rates available to you and what your monthly mortgage payment will be. Even if you are pre-approved, you will still have to go through a full underwriting process to complete the mortgage.The cost of homeownership
Everyone who’s been a homeowner knows there are multiple costs associated with the process. Here’s what to know if you’re a first-time homebuyer, though.Closing costs
Closing costs are the expenses you incur to finalize your loan. These can include but are not limited to- Origination fee
- Title fee and title insurance
- Attorney’s fee
- Appraisal
- Home inspection
- Escrow fees
- Prepaid homeowners insurance and property taxes