What Is A Mortgage, And How Does It Work?
The first steps in buying a home is applying for a mortgage. You may know exactly what “APR” “Discount points” and “fixed-rate” mean, but if this is your first or you need a refresher, there are a lot of resources available on this website.
We’re going to break down these things and more below.
What Exactly Is A Mortgage?
A mortgage is a loan & your home and land are used as collateral. If for some reason you do not pay back your loan, the lender will foreclose on your home. This doesn’t mean the bank owns the house until you pay it off, it means that they have a lien against your property. A lien is the right to take possession of someone else’s property, in this case your home, until a debt is paid off.
How Much Of A Home Loan Can You Borrow?
The first rule of a home mortgage is to never borrow more than you can realistically pay. In history banks have made the mistake of creating many of these types of loans. This is one of the largest factors that led to the real estate crash back in 2008. So many homeowners had home loans that they realistically couldn’t afford, so when the job market took a turn for the worst, banks began having to foreclose on the homeowners properties.
The bottom line here is that you should get a mortgage payment that is not going to be a stretch to pay monthly, but rather than a mortgage that you will not be comfortable with paying. Is traveling a passion? Instead of spending an extra $150 to $250 on a mortgage payment, you could use that extra money to travel.
How Do I Know If I Will Qualify For A Mortgage?
While there are many factors that go into whether or not you’ll be approved for a home loan, the major factors are; your credit score, your debt to income ratio, your work experience, your income level, & the amount of money you have on hand.
If you’re wondering about what your mortgage payment would be, check out our free mortgage calculator.
What Is A Good Credit Score?
Your loan officer & your Realtor will be a great resource for questions around improving your credit, learning what your credit score is, & possibly how much work you’ll need to do before you can purchase a home.
Here’s a quick overview of the credit score “rankings”
Excellent Credit = 720 and above
Good Credit = 660 to 719
Fair Credit = 620 to 659
Poor/Bad Credit = 619 and below
In the simplest terms, the higher the score, the lower the interest rate. Your credit history makes up a large part of your credit score. Almost 35% of your credit score is calculated by using your credit history.
Should You Get A Fixed Or Adjustable Mortgage?
Think about your long term goals with the home that you are buying. If you’re planning on staying in the home until the mortgage is fully paid off, a fixed rate mortgage loan may be your best option. This will ensure that your interest rate will not go up. The only things that could change your house payment over time are property taxes and insurance rates, but those will change no matter what.
An adjustable rate mortgage may be a better option if you will be selling in the near future (think 5-10 years). These mortgages normally come with a lower interest rate up front, but it is possible that your rate may jump in the near future. If your rate is going to change in 5 years, but you were already planning on selling the home, it doesn’t mean much to you.
Alternatively you can also get a hybrid adjustable rate mortgage. This means that your interest rate may be fixed for a certain number of years (3, 5, 7, or 10) then your interest rate may adjust annually for the remainder of the loan. The risk with an adjustable rate mortgage is that you don’t sell, your payments may go up & you may not be able to refinance.
What Are Discount Points In A Mortgage?
1 point is equal to 1 percent of your total home loan. Your lender may offer to sell you points in exchange for a lower interest rate. A point does not equal a percentage rate drop in your interest rate. By purchasing a point from your lender, they should be able to tell you how much your interest rate will change. You can usually buy points in one-quarter increments.
It makes sense to buy discount points when you plan on staying in the home long term. If you plan on moving in a few years, buying points to get a better interest rate may not make sense because you won’t recoup your initial investment.
If you plan on staying in your home, and you don’t think you will refinance anytime soon, points might make sense. You will need to make the choice between lower interest rates over the life of the loan or no points up front. Work with your loan officer to see what makes sense to you.
What Is A Good Interest Rate?
Oftentimes you’ll hear in the news or see advertisements online with headlines such as “Lowest interest rates in history!” or something along the lines of that. These headlines aren’t necessarily the loans you will qualify for. Interest rates vary by location and change daily. They also vary depending on your unique financial situation; such as income, credit scores, and debts. A great place to start is to reach out to your loan officer & see what types of interest rates they are seeing in the current market.
Why Is Your Percentage Different From The APR?
The annual percentage rate (APR) includes fees and points to arrive at an effective annual rate. Because different lenders charge different fees and structure loans differently, the APR is the best way to compare what each lender is offering.
An example may be, Lender #1 is offering you a low 2.0% interest rate that sounds a lot better than Lender #2s offer a 3.5% interest rate. But lender #1s’ offer includes points & high fights. Overall in this situation, Lender #2 with the higher interest rate may be the better long term solution.
What Is Amortization And Should I Care About It?
Amortization is what you are actually paying per year against your loan. Most mortgage loans come with terms over the next 10, 15, or 30 years. You pay each money and the principal of the home loan decreases until it’s fully paid off. The payments don’t change, but at the beginning of the term, most of the payment is going toward interest. By the end of the term, the majority of your payments are going to the principal of the mortgage.
Using our mortgage calculator on our website, find out how long your home loan will be amortized.
What Is Private Mortgage Insurance?
Private mortgage insurance is usually required if you put less than 20 percent down on your home, this insurance protects the lender in case you default on the loan. Some loan programs are not protected by private mortgage insurance, but rather they are backed by the government. These types of loans are primarily FHA and VA loans. There is no monthly mortgage insurance on VA loans, however you will have monthly mortgage insurance on a new FHA loan.