A guide to mortgages, including different types of mortgages and descriptions of mortgage terms and qualifications.
Buying a home or property can be a huge investment, and if you’re like most
people it’s an investment that you can’t pay for out-of-pocket. As you may be
aware, that’s where a mortgage comes into play… but do you really know what a
mortgage is? Sure, it’s a loan on a house or other piece of real estate, but
there’s a lot more to it than that.
Mortgages come in a variety of types and time spans, and can be used to
either purchase a new home or piece of real estate or to secure additional
money using that real estate as collateral. The implications of this are pretty
straightforward… you get the money, but if you don’t pay it back then that
house or property belongs to the bank. Of course, it’s not entirely that
simple… but what else is involved in getting a mortgage?
Basics of a Mortgage
When buying a house or any other piece of real estate, there’s a good chance
that you’ll have to finance the purchase through a bank or other lender.
Chances are they’re not going to lend you the entire amount that you need
(though occasionally you can find one that will), so the first thing that
you’ll need is a down payment. The down payment is the amount of money that
you’re going to pay personally for the real estate, and reduces the amount that
you’ll have to borrow in your mortgage. The larger your down payment, the lower
your payments will be (because you have less to pay back), though in a lot of
cases your down payment can be as low as 5% of the total value of the property
or less.
Once you’ve decided upon your down payment, you’ll apply for a mortgage to
cover the rest. The mortgage will, of course, have to be paid back… and the
bank or loan company will figure out the amount that you have to pay for each
payment using a system known as PITI.
Principal
The principal is the total amount of the loan, and is calculated by
subtracting your down payment from the final price of the property. Obviously,
the higher your principal is the more you’ll have to pay back, so a higher down
payment creates a lower principal and therefore lower monthly payments.
Interest
As with all loans, you’re charged interest on the amount that you borrow for
your mortgage. The interest is based upon interest rates set by the federal
government, as well as any rates that the bank or lender might be offering. The
interest that you have to pay on your mortgage will be figured from the
principal amount that you’re borrowing.
Taxes
When you purchase real estate, you’re going to have to pay property taxes on
it. Failure to pay these taxes could result in the property being seized by the
government, and that would be against the best interests of the lender…
therefore, a portion of your property taxes will often be added to your monthly
payments so that it can be placed in escrow (or held by a third party until a
certain time) until your property taxes are due.
Insurance
Since the lender that issued your mortgage has a definite interest in your
property until they get their money back, you’re going to need insurance. The
amount of insurance that you have can seriously influence your monthly
payments… having good coverage from fire, theft, and acts of nature can reduce
your payment a great deal. If you have less than 20% equity in your property
(equity meaning the portion of it that you’ve already paid for), then you’re
likely going to have to take out private mortgage insurance as well (also known
as PMI.) Private mortgage insurance can get rather expensive at times, so this
is another reason that it’s good to make a large down payment.
Closing Costs
Once you’ve gotten your mortgage approved and they’ve figured up the
payments using the PITI system, you’ve got to take care of your closing costs.
Closing costs are additional fees that cover the work that various members of
the mortgage, realty, and legal teams do, as well as applicable taxes and fees
that are due once the property has been purchased. Depending upon where you live
(and where the property is located), you can usually expect to pay between 3%
and 6% in closing costs. Keep in mind, though, that certain areas have higher
closing costs than others, and some lenders offer a no-closing-cost option on
real estate loans (wherein the closing costs are usually absorbed into the
payments that you make for your mortgage.)
What Types of
Mortgages are Available?
Generally, there are three types of mortgage loans that you will have access
to… fixed-rate mortgages, adjustable-rate or balloon mortgages, and government
loans. Each type has its own advantages and disadvantages, as well as unique
loan options.
Fixed-Rate
A fixed-rate mortgage is a loan that’s made with a locked-in interest rate,
meaning that no matter how much the real estate market may fluctuate you’ll be
paying the same amount for the entire time you’re paying back your loan. If you
lock in a low rate now on a 20-year loan, then 20 years from now you’ll be
paying that same rate no matter how much the interest rates have risen. On the
down side, if you lock in a rate and interest rates fall, you’re still paying
that same amount that you locked in.
Fixed-rate mortgages come in 15-year, 20-year, and 30-year options, with
15-year and 20-year having the highest payments but lower taxes, and 30-year
having lower payments but higher taxes. The 30-year mortgage is also usually
the easiest to qualify for.
Adjustable-Rate or Balloon
An adjustable-rate mortgage has an interest rate that fluctuates depending
upon national rates and market trends. The rate that you pay changes at regular
intervals depending upon the type of loan that you have, as well as caps that
are in place on the maximum amount you’ll have to pay based upon increased
interest rates. There is usually initial period of time in which the rate will
not change, and once it has passed then your rate may change every 6 months, 1
year, 2 years, or more, depending upon the terms of your mortgage.
A balloon mortgage is a bit different, in that it offers fixed lower
interest rates than most fixed-rate mortgages for 5 to 7 years and then you are
required to make a “balloon” payment that pays off the mortgage in its
entirety. Monthly payments tend to be low, though there is the large payment at
the end… however, if you plan on refinancing or selling the property before the
balloon payment is due then this is probably your best bet.
Government Loans
Government loans tend to offer much lower interest rates, though you usually
have to meet certain standards to qualify for the loans. They are designed to
help low-income individuals, veterans, and those living in rural areas to own
their own homes. Most government loans are processed either through the Federal
Housing Administration, the Veterans Administration, or the Rural Housing Service.
Each group has their own qualifications and rules concerning loans that they
make, so you should consult the appropriate agency to make sure that you
qualify.
Qualifying for a
Mortgage
In order to get a mortgage, you need to qualify first. Most lenders require
you to have what is called a debt-to-income ratio of 28/36, meaning that no
more than 28% of your income can go toward your mortgage payment and no more
than 36% of your income can go toward your total monthly debts (including all
other loans, credit cards, and your mortgage payment.) If you don’t have at
least 64% of your gross monthly income to spend on food, taxes, and other
expenses, then you might want to consider saving up some more money so that you
can make a larger down payment (thus reducing your mortgage payments.)
Once you’ve cleared the 28/36 hurdle, you’ll need the following to take with
you for your mortgage application:
The amount of your down
payment (making sure you have enough left over to cover closing costs)
Sales contract signed by both
the buyers and sellers of the property
Social security numbers of
all applicants
Complete addresses for all
applicants for the past 2 years (including names and addresses of
landlords)
Listing of all employers and
all income earned for the past 2 years
W-2 forms from the past 2
years
Current pay stub showing
year-to-date earnings
Banks and account numbers for
all bank accounts, including loans, credit cards, checking and savings
accounts, and any stocks, bonds, or certificates of deposit
3 months worth of your most
recent bank statements
You may also include child support or other court costs if you wish,
bringing proof of payment… the best way to be prepared, though, is to consult a
real estate attorney in your area and get them to help you prepare your
materials. After all, they’ll be able to tell you if you’re missing anything or
have something that you don’t need for your state or area.
Finally, you should understand the difference between being pre-approved and
being pre-qualified. If you’re pre-qualified, then it means that a lender has
looked at the material that you’ve provided for them and they’ve given you an
estimate of how much you can afford to borrow. If you’re pre-approved, then
they’ve checked your credit report and figured out your debt-to-income ratios
and still consider you an acceptable risk to lend money to. It’s better to get
pre-approved than to simply pre-qualify, since that way you know there aren’t
going to be any nasty surprises waiting for you when the potential lender pulls
up your credit report.