Do you ever “window” shop for the perfect home, whether by browsing online or taking a stroll through your favorite neighborhood? You’re not alone. It’s fun to dream about owning a place all your own.
For those getting more serious about the process of buying a home, you’ve probably noticed that some of the next steps are, well, not quite as fun. One of those is acquainting yourself with the mortgage process.
A mortgage loan, a loan to buy a home or other real estate, provides people with the opportunity to purchase a home without having all of the money upfront—which most people simply could not do.
While it is wonderful that mortgage loans open up home ownership to so many, taking out a mortgage is also a big responsibility that should be considered carefully. Our home affordability calculator can help provide you with an better understanding of what is in your budget.
But taking the time to learn about mortgages before you dive headfirst into the buying process might be the way to go. That way, you go into home-financing conversations armed with all the necessary tools.
For those of you asking the important questions about mortgages such as, “What is a mortgage?” “How does a mortgage work?” and “How do I get a mortgage?” we’ve got you covered.
What is a Mortgage?
A mortgage loan, also known simply as a “mortgage,” is a loan used to buy a home.
Mortgages are issued to a borrower who is either buying or refinancing a home or other real estate. The borrower signs a legal agreement that gives the lender the ability to take ownership of the property in the event the borrower doesn’t make their payments according to the agreed-upon terms.
From the borrower’s standpoint, a mortgage is a loan that they’ll pay off via monthly principal and interest payments. The monthly payments are calculated using the loan’s interest rate—which is determined by a number of factors including, but not limited to, the type of loan, a lender’s assessment of a person’s ability to pay back the loan, and the term (or number of months required to repay the loan). Once the borrower has made all principal payments, they will own the property “free and clear.”
Different Mortgage Types
When borrowers apply for a loan, they’ll need to choose whether they want a fixed rate or an adjustable rate and the length of the loan. Most mortgage loan types have 15 and 30-year options.
The interest rate doesn’t change throughout the duration of the loan. Therefore, the monthly principal and interest payment remains the same throughout the life of the loan.
Adjustable-Rate Mortgage (ARM)
With an adjustable rate mortgage, the interest rate is generally fixed for an initial period of time such as 5, 7 or 10 years and then switches over to a variable rate of interest. This variable rate fluctuates with the rate index that it’s tied to.
As the rate changes, monthly payments may increase or decrease. These loans generally have yearly and lifetime interest rate caps that limit how high the variable rate can adjust.
Next, borrowers will need to decide what type of mortgage loan works best for them.
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Conventional loans are loans that are not backed by a government agency, and must adhere to the requirements set forth by Fannie Mae , Freddie Mac , or other investors. Private mortgage insurance is generally required on loans with a down payment less than 20%.
Down payment: Generally between 3% and 20% of the purchase price or appraised value of the home, depending on the lender’s requirements .
Loans insured by the Federal Housing Authority (FHA) are attractive to first-time home-buyers or those who struggle to meet the minimum requirements for a conventional loan. These loans do require private mortgage insurance, and this type of government mortgage insurance premium (MIP) is different from the private mortgage insurance (PMI) associated with a conventional loan.
Down payment: Starts at 3.5%
Loans guaranteed by the U.S Department of Veterans Affairs (VA) are available to veterans, active-duty service members and eligible surviving spouses. VA loans do not generally require a down payment, and although they do not require monthly mortgage insurance, they do require a guaranty fee, referred to as a VA Funding Fee , which can be rolled back into the loan amount. This fee is based on a percentage of the loan amount, and can be waived for certain disabled vets.
Down payment: No down payment available for home purchase, check eligibility.
How Does a Mortgage Work?
There are several components to a borrower’s monthly mortgage payment:
Principal : The principal is the value of the loan. The portion of the payment made toward the principal reduces how much a borrower owes on their loan.
Interest : Each month, interest will be factored into payments according to an amortization schedule. Even though a borrower’s fixed payment may stay the same over the course of the loan, the amount allocated toward interest generally decreases over time (while the portion allocated to principal increases.)
Taxes : To ensure that a borrower makes their annual property tax payments, a lender may collect monthly property taxes with the monthly mortgage payment. This money is kept in an escrow account until the property tax bill is due, and the lender will make the property tax payment at that time.
Homeowners Insurance : Mortgage lenders will require evidence of homeowners insurance, which can cover damage from catastrophes such as fire and storms. Similar to property taxes, some lenders collect the insurance premiums as part of the monthly payment and pay for the annual insurance premium out of your escrow account. Depending on your property location, you may have to add flood, wind, or other additional insurance.
Mortgage Insurance : When a borrower puts a down payment of less than 20% of the value of the home on a loan, mortgage lenders typically require private mortgage insurance (typically called PMI). This insurance acts as a protection for the lender against the risk that the borrower will default on their loan.
What is a Reverse Mortgage?
A reverse mortgage is a way for retirees to generate income for themselves by tapping into their home equity. How does it work? A loan is made to the borrower against the built-up equity value of their home. Often, reverse mortgages are used to help retirees fund the gap in-between retirement and the time when they are able to collect their social security or other retirement income.
The loan can come in the form of lump-sum payments, monthly payments, as a line of credit, or as a combination. Interest and fees—like origination fees or FHA mortgage insurance premium, can be added to the balance of the loan.
Whereas with a traditional mortgage the balance of the loan decreases, a reverse mortgage causes the balance to increase over time. The borrower is not required to make monthly payments on this loan, although they are still responsible for paying other required items due like property taxes, homeowner’s insurance, HOA dues.
According to the Consumer Financial Protection Bureau , “Most reverse mortgages today are federally insured through the Federal Housing Administration’s (FHA) Home Equity Conversion Mortgage program, which means they must comply with the related regulations.”
To be eligible , borrowers must meet certain program criteria, including, but not limited to- being age 62 or older, using the home in question as their primary residence, and borrowing against the equity that they have built in their homes.
How to Get A Mortgage
For lots of folks, it can be a good idea to do some shopping around to get an idea of what is out there.
Not only will you need to choose the lender, but you’ll decide on the length of the loan and the type of loan (fixed vs variable) as well as any applicable loan fees. The first step is to have an idea of what you want, then to seek out quotes from a few different lenders. That way, you can do a side-by-side comparison of the loans.
Once you’ve selected a few lenders to get started with, the next step is to get pre-qualified for a loan. Through this process, based on a limited amount of information, a lender will tell you how much they are willing to lend you.
When you’re serious about taking out a mortgage loan and putting an offer on a house, the next step is to get pre-approved with a lender.
During the pre-approval process, the lender takes a closer look at your finances, including your credit, employment, income, and assets to determine exactly what you qualify for. Once you’re pre-approved, you’re likely to be considered a more serious buyer by home sellers.
When shopping around for a mortgage, it can be a good idea to consider the overall cost of the mortgage (listed above), and any additional fees involved in taking out a mortgage .
For example, some lenders may charge an origination fee for creating the loan, or charge prepayment penalties in the event that you want to pay back the loan ahead of schedule. There may also be fees to third-parties that provide information or services required to process, approve, and close your loan.
To compare the true cost of two or more mortgage loans, look to the APR , not just the interest rate. The interest rate is the rate used to calculate your monthly payment, but the APR is an approximation of all of the costs associated with a loan, including the interest rate and other fees, expressed as a percentage. The APR makes it easier to compare the total cost of a loan across different offerings.
If you’re looking for a mortgage without a bunch of crazy hidden fees, take a look at SoFi mortgage loans.
SoFi mortgages do not have prepayment penalties—but we do have affordable down payment options and competitive rates. Oh, and pre-qualification is painless and easy.
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