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The basics of a mortgage
What is a mortgage?
Your purchase of a home will be among the largest, most important purchases you'll make in your life. There are few things which cost as much; and, few things which will affect your life as much, either.
As a first-time home buyer, therefore, it's important to have a feel for how the home buying process works, and what you should expect from your mortgage.
Your mortgage is the loan you will use to buy your home.
Mortgages are similar to other loans in that there is some amount borrowed; a rate of interest paid to the lender; and, a pre-determined number of years over which the loan must be repaid.
The key part of a mortgage that makes it different from other loan types is that a mortgage loan is specifically used for the purchase of real estate. Also, mortgages can be customized.
There are a bevy of loan programs available for today's home buyers including low- and zero-downpayment loans; loans for buyers of condominiums; and, loans for members of the U.S. military, as examples.
With the help of your mortgage lender, you'll build the loan that best fits your needs.
Why do home buyers use mortgages?
Buying a home ain't cheap.
No matter the price tag, few first-time home buyers have cash on-hand to purchase a home outright. And, those that do have the cash often prefer to keep their cash money for other things in their life.
When you buy a home, then, it's likely that you'll seek a loan from a bank.
A loan used to buy real estate is known as a mortgage.
With a mortgage, the home buyer borrows money from a lender. Those monies are then used to purchase a portion of the home. The remaining portion of the home purchase is paid by the buyer.
For example, if the buyer purchases a home for $300,000 and the mortgaged amount is $270,000, the home buyer is responsible for bringing the remaining $30,000 to closing.
This $30,000 is known as the "down payment". The remaining monies are now mortgaged to the bank, with terms which are customizable between the bank and the borrower.
And, just like every home buyer is different, every mortgage is different, too. Your loan terms are entirely up to you.
How do I qualify for a mortgage?
To qualify for a mortgage, you must meet the minimum standards of whichever loan type you determine is best for needs.
There are tens of available loan types, but the four most common are all U.S. government-backed.
The four government-backed loan types are the conventional mortgage, the VA mortgage, the FHA mortgage, and the USDA mortgage.
Each of the loan types are different, with different qualification standards, the steps to get mortgage-qualified are similar among the four programs.
First, you will need to meet a minimum credit score requirement. This requirement is lowest for FHA home loans; and, roughly equal among the remaining three programs.
Next, you will be asked to verify your income using W-2s, pay stubs, and federal income tax returns. Your debts will be verified, too, using a recent copy of your credit report.
If your credit report happens to include errors or omissions, which sometimes happens, you can provide documentation to your lender to correct such mistakes.
Your lender will also want to verify your employment history and your savings.
How large should my down payment be?
When you’re buying a home, the amount of money you bring to closing is known as your down payment.
You can think of your downpayment as the part of the home purchase price that you’re not borrowing from the bank.
Depending on which loan program you choose to use, your minimum downpayment will vary.
- VA loan: 0% down payment required
- USDA loan: 0% down payment required
- Conventional loan: 3% down payment required
- FHA loan: 3.5% down payment required
Keep in mind these figures are just minimums. You can choose to make a larger down payment, if you want.
When you make a larger down payment, your monthly payment is reduced because you're borrowing less money. And, if you use a conventional loan -- which many home buyers do -- larger down payments are linked to lower mortgage rates.
What will my mortgage interest rate be?
Your mortgage interest rate is "made" in two parts and there's a science that determines what rate you get from the bank.
The first part of your mortgage rate is linked to your loan program.
Of the four government-backed loan programs, VA mortgage rates are often the cheapest, beating conventional mortgage rates by as much as 40 basis points (0.40%), followed closely by USDA mortgage rates.
Next come FHA mortgage rates, followed by conventional rates.
FHA mortgage rates tend to beat conventional mortgage rates by 15 basis points (0.15%) or so, and this may look like a better deal, but price gains made on an FHA mortgage rate can be quickly gobbled up by the cost of FHA mortgage insurance.
Your lender can help you compare the relative value of an FHA loan as compared to a conventional one.
Now, once you've selected your loan type and have been assigned a "base" mortgage rate, it's up to you whether you want to accept it.
Here how it works:
- Your lender quotes you a rate on your loan. Your loan requires closing costs.
- If you want a lower mortgage rate, you can opt to pay additional closing costs.
- If you want fewer closing costs, you can opt to accept a higher mortgage rate.
In this way, you can do a "zero-closing cost" mortgage. As the home buyer, you ask your lender to reduce your loan closing costs and your lender obliges in exchange for a slight increase to your mortgage rate.
In general, for loan sizes of $250,000 or more, you can get a zero-closing cost mortgage in exchange for a mortgage rate increase of 25 basis points (0.25%).
How long do I have to pay back my loan?
As the mortgage borrower, the term of your loan is also up to you. A loan "term" is the number of years until the loan must be paid-in-full.
The most common loan term for mortgage loans is 30 years. However, there are other options, too, including a 10-year term, a 15-year term, a 20-year term, and a 25-year term.
The benefits of a shorter-term loan is that your mortgage rate is typically lower, plus your loan gets paid off sooner.
These factors reduce the long-term interest costs of owning a home so, with a shorter-term loan, it actually costs less to "buy" the home you’re buying.
However, there are reasons to choose a longer-term loan, too. Namely, because mortgage repayment gets spread over a larger number of years, each payment is smaller as compared to the payment with a shorter-term loan.
The payment on a 30-year mortgage can be one-third less than the payment for a comparable 15-year term.
What will my monthly mortgage payment be?
Your monthly mortgage payment is a function of three things: the amount of money you've borrowed, your mortgage interest rate, and your loan term.
For borrowers using a fixed-rate mortgage, you can plug the above three figures into a mortgage calculator to calculate your monthly payment; and, you'll know that the payment will be unchanged so long as the loan is in effect.
This is because fixed-rate mortgages are mortgage loans for which the interest rate does not change -- even if market mortgage rates move higher or lower in the future.
Indeed, this is part of the appeal of a fixed-rate loan -- you know exactly what your payment will be each month, which make it simpler to budget for homeownership.
The opposite of a fixed-rate mortgage is an adjustable-rate mortgage (ARM). With an adjustable-rate mortgage, your mortgage rate -- and, therefore, your mortgage payment -- is subject to change.
With an adjustable-rate mortgage, your loan’s interest rate remains unchanged for a number of years, and then can vary during the remaining term of the loan.
The most common "teaser" periods for adjustable-rate loans are 5 years and 7 years. After this period ends, ARM mortgage rates can change up to once per year.
ARMs can adjust higher, but they can also adjust lower, too. Downward adjustments are common during periods of economic weakness and uncertain growth.
Since 2003, home buyers with ARMs have routinely "beat the market".
What are today's mortgage rates?
As a first-time home buyer, understanding how your mortgage works is the first step to making better mortgage choices -- and getting the best rate possible.
Get today's live mortgage rates now. Your social security number is not required to get started, and all quotes come with access to your live mortgage credit scores.
How To Buy A Home (Infographic)
