Mortgage Basics
1. Mortgage Basics
Although each individual home financing package has its own variety of features, the concept of a mortgage is really quite simple: a mortgage is a loan made to help you finance a home. Your lender advances you a certain amount of money, which you repay over a specified period.
Rates, Discount Points & Loan Fees
The total cost of your mortgage is determined by a number of different factors, the interest rate, discount points, and loan fees. The expenses that contribute to the cost of your loan can be expressed as the annual percentage rate (APR).
Interest Rate refers to the percentage of your outstanding loan balance that you pay the lender each month as part of the cost of borrowing money. Your interest rate will be based on the current overall rate environment, as well as your financial profile and the specific features of your loan.
Discount Points allow you to “buy down” your interest rate at closing. One point equals 1% of your loan amount, and the more points you pay, the lower your interest rate will be, and the less you will have to pay each month. How much your rate will decrease with each discount point you pay will depend on the specific features of your loan.
Loan Fees are up-front charges to cover the cost of originating, processing, and closing your loan, among other things. An origination point is a loan fee that equals 1% of your loan amount.
When considering loan pricing, keep in mind that rates, points and fees should be considered together. The interest rate alone only tells part of the story.
Your Monthly Mortgage Payment
Mortgage payments can generally be divided into four parts: principal, interest, taxes, and insurance. These are often referred to with the acronym PITI.
Principal refers to the amount of money you borrow to buy a home, and to the outstanding loan balance at any point during the mortgage term. Interest is the cost of borrowing money. As noted above, the amount of interest you pay each month is determined by your interest rate. Taxes assessed by your local government will likely be collected by your lender as part of your monthly payments, and then paid annually or semi-annually on your behalf. This process is known as an escrow.
Insurance, like property taxes, is normally collected by the lender in an escrow account. Insurance offers financial protection, and has two major components: Homeowner's insurance, also called hazard insurance, protects you against damage to your property caused by fire, wind, or other hazards. Mortgage insurance protects your lender in the event that you fail to repay your mortgage. Whether you must pay mortgage insurance usually depends on the loan program and the size of your down payment.
Note that the loan's APR doesn't figure into the calculation of the monthly payment. The APR reflects all the costs of your mortgage, including not only the quoted interest rate (used to calculate the principal and interest) but also required loan fees such as loan points, fees and mortgage insurance.
Selecting the right mortgage is central to the homebuying process — that's why it's so important to understand your options. You'll need to consider two things at the outset: which loan type meets your homebuying needs, and which loan term offers the ideal repayment schedule.
2. Loan Types
Most home loans fall into one of two general categories: fixed-rate and adjustable-rate mortgages (ARMs).
Fixed-rate mortgages
Fixed rate mortgages have interest rates that stay the same for the entire life of the loan. You will have predictable monthly payments throughout the life of the loan. You'll be protected from rising rates, so your principal and interest payments do not change, no matter how high interest rates rise.
Adjustable-rate mortgages
Adjustable rate mortgages have interest rates that adjust periodically based on market conditions.The initial rate is fixed for an introductory period (usually three to ten years), and is typically lower than for a fixed-rate mortgage. After that, the rate adjusts annually or semi-annually depending on the product and based on a market index, but it can't go above a predetermined adjustment cap. Because of the lower initial rate, some borrowers may be eligible for a larger loan amount with an ARM than with a fixed-rate mortgage.Find the right combination of loan features to support your financial goals.
3. Loan Terms
The “term” of a loan is the period of time you will spend repaying it.
The most common loan term is 30 years, but other options are also available. There are 20-, 15- and 10-year mortgages for those who want to repay their loans faster. Whether you’re better off with a longer-term loan or a shorter-term loan depends on a number of factors, most notably your monthly income and your long-term financial goals.
Comparing two fixed-rate loans with different terms:
The longer-term loan will offer lower monthly payments. This may be a good option if you’re on a tight budget or would prefer to direct your monthly cash flow toward other investments or expenses.
The shorter-term loan will mean higher monthly payments, but you’ll be repaying the loan faster and potentially reducing loan interest.
Other Considerations
Besides the nature of the interest rate and the loan term, other important features of a mortgage loan include: Whether the loan amount is above or below what is known as the “conforming loan limit” set by Fannie Mae and Freddie Mac*. Mortgages larger than this amount are termed “jumbo loans” and require higher rates than similar conforming loans.
Whether the loan can be insured or guaranteed by a government agency, such as the FHA or VA.
FHA loans are backed by the Federal Housing Administration, and are designed to assist low-to-moderate income homebuyers by providing low down payment requirements and flexible qualifying guidelines.
VA loans are backed by the Department of Veterans Affairs (formerly the Veterans Administration), and are available to qualified veterans and active-duty military personnel and their spouses. They provide many of the same features as FHA loans.
Whether the loan has flexible qualifying guidelines, which may be able to accommodate borrowers with credit challenges, excessive debt, or previous bankruptcy, foreclosure or tax delinquency.
Most mortgage companies offers a wide variety of product options to meet your unique homebuying needs. Let us help you find the right combination of loan features to support your financial goals. Contact us to get started today!
A preapproval is your lender's written agreement to finance your home purchase up to a specific amount, subject to certain conditions. Getting preapproved is a smart move for serious homebuyers because it shows sellers that you come to the negotiating table ready to complete the transaction.
4. Preapproval vs. Prequalification
A preapproval indicates that a lender has taken a detailed look into your financial background and has committed to lend you a certain amount of money, pending specific property details. Because preapproval includes a credit check, it's more powerful than a prequalification letter, which generally only estimates what you can borrow based on information you've provided. Shop for a home with the confidence of knowing exactly how much you can borrow.
Preapproval offers a number of advantages over waiting to apply for a mortgage until after you've found a home. It lets you:
- Shop for a home with the confidence of knowing exactly how much you can borrow.
- Take advantage of the preference many home sellers have for preapproved buyers.
- Find out about possible qualification problems early in the homebuying process.
Preapproval is a great advantage for anyone buying a home, but it can be especially useful for buyers looking for their first home and those who are self-employed or work on commission.
First-time homebuyers. Without a record of previous mortgage payments, sellers may see first-time homebuyers as less likely to obtain financing than a similar buyer who's already demonstrated the ability to meet a monthly mortgage payment. A preapproval helps even the field by showing the seller that a lender has already run the numbers and is willing to proceed with the transaction.
Self-employed buyers or commissioned employees. Because their incomes may fluctuate more dramatically, self-employed and commissioned buyers often lack the financial documentation of salaried employees, which can send up a red flag to some sellers. Showing that a lender has already considered these factors will help mitigate this risk.
5. How does the process work?
Before you begin shopping for a home, submit your financial information to the lender of your choice. They will review your data and then, if you meet qualification requirements, will provide you with a written preapproval for a certain mortgage amount, down payment, and interest rate, subject to the terms of the commitment letter. The loan commitment letter can be finalized after information about the property, including an appraisal, is submitted. We can help you with this entire process.