Applying for a mortgage for the first time can be stressful if you don’t know what to expect.
You can eliminate undue stress by learning ahead of time the basics of a home mortgage.
What Is A Home Loan or Mortgage?
In simple terms, a mortgage is a loan secured to purchase a home. When you sign a mortgage, your lender agrees to loan you money to make your purchase. You agree to pay back that amount, plus interest and other expenses, in monthly installments over a stipulated period.
What Is the Difference Between Loans and Mortgages?
Loans and mortgages are similar, barring a few key differences. Standard loans come in different forms; personal loans and business loans are the two most well-known examples.
A mortgage, meanwhile, is a loan specifically designed to help you to purchase a home. While your credit score still plays a role in your eligibility, one key difference is that mortgages use your home as collateral.
A mortgage is a secured loan. If you miss payments, your lender will use your home as the collateral asset. That means your lender can sell your house via foreclosure to get repaid.
What Is Included in Your Monthly Mortgage Payment?
Lenders typically let you choose from a 15 or 30-year period for the life of your loan. A shorter duration means you save on interest. However, your monthly payments are higher.
Sometimes you may owe more than just this every month; this may happen if your lender takes the responsibility of paying your property taxes and the homeowners insurance.
In that case, you’ll need to pay additional money each month into an escrow account. Your lender will then use that account to pay for your tax payments and insurance premiums.
In the initial period of your repayment, more of your money will be channeled towards your loan’s interest and less toward its principal. But as time goes on, you’ll pay more toward the principal; this process is called amortization.
Things You’ll Need to Secure A Mortgage
To qualify and then secure a mortgage, you’ll need:
● A good credit score
● A down payment
● A low debt-to-income ratio
Credit scores range from 300 to 850, and a score of 620 or above is typically considered good. If your credit score is below par, it pays to improve it before applying for a mortgage. Paying your bills on time and paying off a considerable chunk of your total existing debts is beneficial when improving your credit score.
You’ll need to put some down payment toward the purchase of your home. Generally, you’ll need a 20 percent down payment when you take a loan to avoid private mortgage insurance or PMI. PMI is a premium designed to protect your lender in the event you’re unable to pay your mortgage payments. It usually gets bundled with your monthly mortgage payment and totals 0.5 percent to 1 percent of your mortgage amount.
Finally, your debt-to-income ratio (DTI) measures the amount of money you owe each month on existing debts compared to your monthly earnings. If you owe too much, lenders will be less inclined to loan you money. If this ratio isn’t favorable, pay off or reduce existing debt or try increasing your income. A good DTI is 36 percent or lower, with 43 percent being the highest to qualify.
What Are Closing Costs in A Mortgage?
When you lock a mortgage, you’re liable for an array of fees. These fees are collectively known as closing costs. Closing costs are typically between 2 percent to 5 percent of your mortgage’s value.
Buyers generally pay closing costs as a one-time out-of-pocket expense at closing, or, in some cases, you can roll them into your mortgage and pay them off over time with interest. Your lender is required to estimate the closing costs well ahead of time so that you are prepared.
Types of Mortgage Loans
Not all mortgages are equal. There are various types of mortgages, each tailored to cater to a specific requirement. Here are some of the different types of mortgages you should know about:
● Conventional Mortgages
Conventional home loans are guided by the maximum limits set by Fannie Mae and Freddie Mac, agencies that back the majority of U.S. mortgages. With conventional loans, you’ll need to pay PMI if you fail to put down 20 percent on this mortgage.
● Jumbo Mortgages
These are conventional mortgages that go beyond the maximum borrowing limits. A Jumbo mortgage is harder to secure than a traditional mortgage. Historically, the interest rates on jumbo mortgages are higher; however, with GSE (government-sponsored enterprises) fees increasing, Jumbo loans are seeing lower interest rates than conforming loans.
● FHA Loans
These are mortgages backed by the Federal Housing Administration and are designed for applicants who don’t have a good credit score or don’t have the funds for a large down payment. For example, if your credit score is 580 or above, you can put as little as 3.5 percent down with an FHA loan. However, you pay certain premiums with an FHA loan that can increase your monthly expenses.
● VA Loans
These mortgages are available to active as well as veteran members of the U.S. military. These loans don’t require you to make a down payment and don’t charge PMI either. However, there are funding fees involved that get added to your mortgage costs.
● USDA Loans
Supported by the U.S. Department of Agriculture, the USDA loans help lower-income borrowers buy homes. If you qualify for this loan, you won’t have to make a down payment, but that home must be in a designated rural zone listed by the agency.
Figure Out Your Mortgage Budget
Once you understand how mortgages work, you should figure out how much mortgage you’re willing to take out and if you can get that amount.
Even if mortgage lenders are willing to lend you a large sum, don’t go for it if you can’t afford it because it will squeeze your finances and strain your budget after getting your new home.