What Is a Mortgage?
Let’s start with the basics. Most home buyers don’t have enough money to buy a house outright for the listing price, which is why mortgages exist. A mortgage is a long-term home loan provided by a bank or mortgage lender to help you purchase property. When you buy a house, the property acts as collateral in exchange for the funds you’ve borrowed. Typically, mortgages last 15 to 30 years of monthly payments.A mortgage is made up of several parts:
- Collateral — in this case, the home itself
- Principal — the sum of money you borrowed
- Interest rate — percentage the lender charges you to borrow the money
- Monthly payment — the amount you pay back on your loan each month
- Mortgage terms — length of time that the mortgage agreement with agreed interest rate is in effect
- Insurance — homeowner insurance protects your property in the case of fire, theft, bad weather, etc.
- Property taxes — a percentage of the value of your home levied by the county
The Many Mortgage Decisions
All mortgages are not created equally. There are different types of mortgages with varying terms and interest rates. When you finance your home, you will need to decide on the right type of mortgage for you. You should take into account your own personal financial situation, the current market, and your long-term plans regarding the house you’re buying (whether it will be your forever home or a starter home).
First, make sure you understand mortgage terms and interest rates before you decide.
A mortgage term is the period of time that a lender will agree to finance you at the agreed interest rate. In short, it’s the length of your mortgage. Mortgage terms range anywhere from 6 months to 5 years to 40 years, but are most often either a 15-year or 30-year mortgage. If you let the mortgage term close before paying off the loan or refinancing, the rest of the money is owed in full.
Your monthly payments and the amount of interest you’ll pay overall will be determined, in large part, by the mortgage term. For example, a 15-year mortgage will require higher monthly payments than a 30-year mortgage because you’re agreeing to pay it off in half the time, though you will likely pay less interest in a shorter mortgage term.
However, the amount of interest you pay will ultimately depend on the market as interest rates can surge or drop unpredictably. Make sure you talk to an experienced agent or lender before deciding on your mortgage term. You need to figure out just how much risk you can handle and base your decision on the current market rates. If you choose too short of a mortgage term and interest rates take a strong upward spike in your area within that term, will you still be able to afford your home? Or, if you select a 30-year fixed mortgage and end up moving in three to five years (which is very common in our area), you could be leaving hundreds of dollars on the table.
It is possible to refinance your mortgage, but the process takes time and the interest rate is still dependent on the current market. If you’re not sure which mortgage term is the best one for you, consult with your real estate team; your dream team will be able to steer you in the right direction.
Mortgage Amortization Periods
Before we go any further, note that amortization is just a fancy word for a scheduled debt-repayment plan. Together, a mortgage amortization and a mortgage term affect the amount of money you can borrow, and in turn your monthly payment. Lenders will calculate mortgage payments over a long period of time, but this timeframe isn’t the same as the mortgage term; it’s their best guess at how long it will take you to pay back the money lent plus interest.
Generally a longer amortization period means a lower monthly payment, but higher interest. You can always adjust the mortgage amortization period based on market trends and your own financial situation, so don’t worry about enduring fluctuations in your financing — it happens to everyone. You can also renew the mortgage multiple times during the amortization period, but you are subject to additional fees when you refinance. Many of our clients choose a 30-year amortization, but make additional payments to reduce the timeframe it will take to pay off the loan and save money on interest. It’s important to discuss this type of strategy with your agent and lender.
Mortgage Loans & Interest Rates
The interest rate on your mortgage is one of the biggest factors contributing to the total cost of your home because the rate — along with the term — will determine the amount of your mortgage payments. The interest rate you first commit to at the start of your mortgage term can significantly affect your monthly payment, so it’s important that you choose a loan rate that works with your budget.
The two most common types of mortgage loans are those with a fixed-rate and those with an adjustable-rate in terms of interest. There is also the option to do a hybrid loan that combines elements of both a fixed-rate mortgage and an adjustable-rate-mortgage. Below we’ve broken down each type of mortgage loan:
Interest rate stays the same for the entire life of the loan — predictable
Monthly payment remains the same month-to-month
Ratio of interest and principal will vary slightly per month
Most commonly paired with a 30-year mortgage term
Good in an economy where interest rates are going up, but risky if interest rates go down
Better for those planning on living in home long-term
Safe bet for first time home buyers
Interest rate will change at pre-determined times for the entire life of the loan
Risky if interest rates are going up — rate change unpredictable
Limitations on how much the rate can change month-to-month
Interest rate lower at the beginning of the loan
Best for those who only plan on staying in the home for a short time
Most common terms are 3/1 and 5/1 (rate period / number of adjustments)
As we mentioned already, interest rates are determined by the fluctuations of the present economy, but banks and mortgage brokers in your area should offer competitive rates. However, if you get offered an interest rate that seems too good to be true, it probably is. There are predatory lenders that will use shady tactics, such as the Bait and Switch, to prey on inexperienced home buyers and rope them into bad deals.
Types of Mortgages
The three most common types of mortgages are conventional mortgages, second mortgages, and high ration mortgages. Your agent will be able to sit down with you to determine which type of mortgage is right for you and your family, but take the time to familiarize yourself with each of them, so you can be as prepared as possible.
Most common type of home mortgage
Up to 80% of the home’s purchase price can be lent
Down payment will cover the remaining 20%
Allows for additional financing options for existing mortgage
Usually arranged at higher interest rate
Usually arranged for a shorter term
Note: a common reference is an 80/10/10 which means 80% for the first loan, 10% for the second loan, and 10% down. This can give you the advantage of no Private Mortgage Insurance (PMI) and a second loan — which is at a higher interest rate — that you can pay off first to get the most competitive rate on your first loan at 80% (which you will keep for the longest time).
High Ratio Mortgage
Up to 95% of the home’s purchase price can be lent
Lower down payment (<5%)
Must pay cost of insurance for mortgage against default, which is then added to the principal (PMI)
Mortgage Protection Insurance
You are required by law to get mortgage protection insurance if you cannot afford to put more than 20% down to purchase your home. You can choose to work with a company in the private sector or work with the federal government to insure your mortgage. Mortgage insurance will pay the bank for you if your house goes under foreclosure.
Mortgage insurance can protect you in a catastrophic life event such as disability, job loss, or death by paying for your mortgage on your behalf. The cost of mortgage insurance depends on your current health, age, and financial status.
If you do choose to work with the federal government to insure your mortgage, you will have to choose between two types of government backed loans:
Federal Housing Administration (FHA) Loans
Managed by the Department of Housing and Urban Development
Available to all types of buyers and borrowers
Smaller down payment
Easier to get approved compared to a conventional mortgage
More flexible with credit scores
Higher debt-to-income ratio allowance
More forgiving for a history of foreclosure or bankruptcy
Veterans Affairs (VA) Loans
Managed by the U.S. Department of Veterans Affairs
Available only to service members and their families
No down payment
Can receive 100% financing
Easier to qualify in comparison to a conventional mortgage
Lender can provide you with more favorable terms
No specific requirements for credit scores
Choosing a Lender
Once you have a good understanding of what a mortgage is, how it works, and all of the various components involved in financing a mortgage, you’re ready to find a lender.
Some buyers will search for a lender before they find a real estate agent, but this is a dangerous first step because not all lenders are trustworthy. Predatory lenders know all the tricks in the book, and it’s up to you to avoid them. Unfortunately, if a lender leaves you high and dry at the closing table or adds additional costs at the end, you as a single borrower have very little leverage. Therefore, we recommend you choose your agent first, so they can help you choose a verified lender.
The Keri Shull Team has helped hundreds of clients successfully finance their homes over the years by referring our clients to only a few trusted partners that we personally vet. If there is ever an issue, our lenders take great strides to amend them because they know how valuable our business is to their own. That is why our lenders never break their commitments to our clients and always close on time. Take advantage of our experience by asking us who you can trust.
Though we advise against it, if you decide to search for a lender without the help of your agent, you can start by talking to your own bank. They will already have your financial information including account balances, credit cards, and investments, and they will likely be the most motivated to give you a good rate to keep your business.
You can also work with a mortgage broker. Mortgage brokers work with many different lenders and will do the legwork for you; they will contact the lenders on your behalf to find you the best possible mortgage rate and term. Better yet, most brokerage fees are paid for by the banks anyway. Just make sure that the broker you choose puts your best interests first.
Once you’ve chosen a lender, you’re ready to move on with the financing process and get pre-qualified. In order to pre-qualify for a mortgage, your lender must take into account your total income and your debts to determine your down payment. This will give you a good idea of your budget. The pre-approval process is fairly easy and will only take you about five minutes on the phone with one of our trusted partners. You then must take your pre-qualification to the next level by getting pre-approved for a mortgage.
The pre-approval will show you the current interest rate once you offer proof of income and credit history in writing, and it covers you for 3 to 4 months. It’s important to remember that a pre-approval is only the first step and does not guarantee how much money a lender will loan you; the lender first has to confirm that the home you’re purchasing is worth it. Once you identify a property that you’re interested in buying, the bank will conduct an appraisal to determine their perception of the market value, and the amount they lend you will be determined at that time.
If you skip this step and move right on to house hunting, you risk wasting time on homes you can’t afford and missing out on the perfect house. Getting pre-approved for a mortgage allows you to create an informed maximum price point. Once you know your rates, you can really focus your search and eliminate the guesswork. You will have the information you need to approach the rest of your home buying process with confidence.
After you’ve been pre-approved for a mortgage, you will know how much money you can spend on a home and be able to estimate how much your mortgage payment will be each month.
The majority of mortgage payments are blended, meaning they are based on principal and interest. The principal is the amount your borrowed from the lender and need to pay back. The interest rate is how much the lender charges to lend you the money. So generally speaking, the more money you can afford to pay on your mortgage early on, the less total interest you’ll have to pay on top of that.
Over time, the portion of money in each mortgage payment required to pay off the principal increases. An experienced agent will be able to offer you many solutions to paying down your mortgage faster, including large lump sum payments or multiple payments a month. Since interest rates are so low right now in our area, many of our clients feel they can get a greater return by investing their additional cash instead of paying interest. There are many different perspectives regarding the wisest approach.
It’s important to choose an agent you can trust, so that you feel comfortable discussing your finances with them in these moments. Your agent should always be looking out for your best interests, so don’t be afraid to involve them in your mortgage decisions.