Mortgages

At some point in their lives, most people aspire to be homeowners. Buying a house is one of the most significant financial decisions that people make in their lifetime, so of course it’s important to think things through and plan ahead. You probably wouldn’t be reading this if you could afford to buy a house outright in cash – so when it comes time to purchase a home, you’ll need a mortgage.

Mortgages can seem intimidating for first time homebuyers or people who aren’t especially well versed in finance, but don’t worry. We’ll cover all of the mortgage basics, terminology, tips, and common questions that you’ll need to know to get started on your journey to home ownership.

Mortgages are a lot like most loans at a high level. They include interest rates, terms, down payments, approvals, and other loan essentials. With the home being considered collateral in mortgage loans, you run the risk of losing your home if you fail to repay your loan as agreed upon in your mortgage contract. This process is similar to repossession in things like car loans, but in home ownership this process is called foreclosure.

Getting a mortgage is a huge commitment that shouldn’t be taken lightly. You need to make sure that you’re financially prepared to take on the responsibility of home ownership. There are many advantages of mortgages, however, for some there may be other housing options such as renting a home or apartment that make more sense for the time being.

Home ownership is a huge life milestone. It allows you to build equity in your property in hopes to sell in the future or pass it on with a far higher value than when you bought it. In this sense, the cost of a mortgage is an investment. Making a good home purchase can make building equity and your next move far easier and less stressful. 

Unlike an apartment, where any modifications will be wiped clean when you leave, a mortgage allows you to build something that is your own and allows more freedom with renovations and modifications.

Of course there is a flipside to the positive side of mortgages. There are more associated costs on top of your mortgage payment such as property taxes and homeowners insurance, which can often make it more expensive than renting. 

There are also more responsibilities that having a landlord allows people to avoid. Any damages or needed home repairs and property upkeep is all on the homeowner when you decide to purchase. 

Permanence could be considered a con depending on your point of view. It’s more difficult to pack up and leave on short-notice when you own your home. The tradeoff for this permanence is of course the ownership and opportunity to build something that is truly yours, so it depends on your perspective and future goals.

Mortgage payments are split into four categories throughout the life of your loan. A common acronym for these mortgage payment categories is PITI, which stands for principal, interest, taxes, and insurance.

Mortgage payments follow an amortization schedule, which breaks down each payment to show which categories you will be paying to over time. When a mortgage is first taken out, interest makes up a larger portion of monthly payments. As borrowers progress through their loan term, this percentage decreases and more of each monthly payment goes toward the principle.

Sometimes there may be options available to pay more of your interest upfront, so monthly payments chip away at your mortgage’s principal more aggressively.

There are several different types of mortgages, each holding their unique pros and cons. Ultimately, it is dependent on the borrower’s unique situation as to which mortgage type is best suited for them. 

Factors that make up different types of mortgages include the type of rate, the term or length of the loan, whether or not the loan is backed by the United States government, and the size of the loan amount.

There are two common rate types that are used in mortgages: fixed and adjustable (ARM). Fixed-rate mortgages are more common, but often come with a slightly higher interest rate than ARMs at the time of signing.

A fixed-rate mortgage is a loan in which the interest is set, or “locked” upon signing and will not change over the life of the loan.

An adjustable rate mortgage (ARM) is a loan in which the interest rate can change throughout the duration of your mortgage. These are often referred to as variable-rate mortgages as well.

ARM rates are determined by an index of international interest rates and can fluctuate with the economy and actions of the Federal Reserve.

Another factor of different mortgage types is the term of the loan. This is a measure of how long the borrower has to pay off the loan amount. The longer your loan term, the lower your principal payment is each month, however, there are of course drawbacks to this as well.

The most common mortgage terms are 15-year, 20-year, and 30-year. However, there are many different options that vary by mortgage company that can be higher or lower than this range and may even have more customizable options to fit the borrower’s budget.

If you can swing the larger payments, we definitely recommend choosing a shorter mortgage term. It’s important that you don’t put yourself in a bad spot or stretch your finances too thin, but choosing a 15-year mortgage over a 30-year could save you upwards of $100,000 over the life of an average sized home loan.

A common home loan through a mortgage company, bank, or credit union is considered a “conventional” loan. This is a standard agreement between borrower and lender, with the home as collateral, and relies on the rates and terms set at the time of signing. 

There are also several other types of home loans that are backed by the government. These mortgages often have more lenient approval criteria, lower costs, or both.

FHA loans are a special type of mortgage that is government backed by the Federal Housing Administration (FHA), which is an agency of the Department of Housing and Urban Development (HUD).

These mortgages are geared to help those with existing debt or a lower credit score obtain a mortgage by having more lenient financial requirements in comparison to conventional loans. This can be accomplished by offering borrowers a lower down payment requirement, financing the closing costs as part of the loan, or lowering the credit requirements.

There are certain requirements that the borrower and home must meet to be approved for an FHA loan.

USDA stands for the United States Department of Agriculture, which provides specialized loans for qualified borrowers in rural areas. Typically USDA loans have no down payment or mortgage insurance requirements, but have an additional upfront fee.

Military families may qualify for a VA loan, which is backed by the U.S Department of Veterans Affairs. Much like USDA loans, VA mortgages usually have no down payment or mortgage insurance required, but have a funding fee upon signing.

The amount that the loan is for can also help determine the type of mortgage. Usually a loan will be either categorized as a conforming or jumbo loan – jumbo of course being the larger of the two.

What is considered a conforming mortgage varies slightly by location due to some areas being higher cost than others. The limit for being considered a conforming loan is $484,350 for most single-family homes in the United States, with the exception of the District of Columbia, Alaska, Hawaii, Puerto Rico, and some other U.S. Territories being $726,525 due to a much higher cost of living. [1]

Non-conforming loans are often referred to as jumbo loans, which exceed the limits above. These loans are put into a separate category due to the amount of risk that is involved for a lender to allow that much money to be borrowed. With that being said, jumbo loans typically have more strict requirements.

Depending on the type of mortgage you are taking out, there are different requirements that borrowers must meet. These mortgage approval requirements are primarily based on a few key factors.

Conventional loans require a credit score of at least 620, however there are some options for those with lower credit scores like government-backed FHA loans, which can be approved for borrowers with credit scores as low as 580. [2]

Better credit scores will increase your chances of an easy approval and help secure better terms for your mortgage.

One key factor that lenders look at when taking out any loan is your debt-to-income ratio, or DTI. This measurement helps gauge your ability to pay back the loan by comparing your income to existing debt.

Lenders prefer low debt to income ratios, usually no more than 45% for most mortgages.

Some types of mortgages may not require a down payment, and those that do vary in amount depending on the individual borrower’s financial situation and the home they’re looking to purchase.

Down payments are cash paid upfront when taking out a loan. This cuts down on the amount borrowed, often putting borrowers in range of the amount of risk a lender is willing to take.

For conventional mortgages with down payments less than 20%, PMI (private mortgage insurance) is required. To avoid this extra cost, many home buyers aim to save up for a 20% down payment before buying a home.

There are many different lenders that you can compare rates for when choosing the right one to finance your mortgage. It’s important that you not only compare rates, but any terms or eligibility requirements as well. 

Many major banks and credit unions offer mortgage loans as well as several non-bank mortgage companies.

Non-bank mortgage providers offer many of the same financing capabilities and competitive rates that banks do, but these companies specialize in loans and typically do not offer banking services as well.

These companies create loan programs using a variety of funding services like national banks, but they are still the ones funding the loan unlike mortgage brokers. By specializing in mortgages, these companies can sometimes be quicker to close or provide additional services or technology to help you along the way with your mortgage that most banks won’t.

You can also try to finance your mortgage directly through your bank or credit union. Sometimes you may find better mortgage rates, so it’s important to consider. 

Your bank may not have the expertise of a mortgage company or be able to move quite as quickly. Be sure to check in on both bank and mortgage company options when shopping around.

Throughout the process of getting a mortgage, you may encounter terms that you haven’t heard before. It’s important to get familiar with some of these terms and what they mean so there’s no confusion or misunderstanding when working through the mortgage process.