Mortgages are typically the largest and longest loans most Americans will have in their lifetimes. The process of getting a mortgage can be stressful and may appear complicated. But you can tackle it by understanding the process and taking a handful of steps toward buying or refinancing a home.
What Are Mortgages and How Do They Work?
A mortgage — or mortgage loan — is a contract between you and a lender for a loan to buy or refinance a home or other real estate. The mortgage allows you to buy a home without having to pay all the cash up front.
Mortgages differ from other types of loans since a mortgage is specifically for the purchase of real property.
The house or other real estate serves as collateral — an asset the lender accepts as security for the loan. If you fail to make payments on the mortgage, the lender can take the property to pay off what you owe on the loan.
You don’t fully own the property until you complete paying off the mortgage.
Mortgage rates are the rate of interest your lender charges for your home loan.
There are two types of mortgage rates: fixed rate and adjustable rate.
- Fixed-rate mortgages have an interest rate that stays the same for the entire term of your mortgage. They are typically easier to budget for because they give you a steady and predictable monthly mortgage payment.
- Adjustable-rate mortgages change the amount of interest you pay based on changes in overall interest rates. You have a fixed interest rate at first — these typically last five, seven or 10 years — before rates begin to vary based on the market. At that point, your interest rate may increase or decrease every six months to a year, based on the terms of your mortgage.
You pay off the mortgage over its term, which is the length of time that payments are spread out. The most common mortgage terms are 15 and 30 years. Some lenders also offer 20-year mortgages.
All mortgage rates fluctuate significantly depending on the economy, interest rates, as well as the term and type of mortgage.
|MORTGAGE TYPE||JAN. 14, 2021||JAN. 15, 2021||JAN. 13, 2022|
|30-year fixed rate mortgage||2.79%||2.88%||3.45%|
|15-year fixed rate mortgage||2.23%||2.22%||2.62%|
|5/1-year adjustable-rate mortgage||3.12%||2.47%||2.57%|
It’s important to check and compare mortgage rates from several different lenders when shopping for a home loan.
During the term of your mortgage, you typically make monthly payments that include the principal of the mortgage loan, interest, mortgage insurance and taxes.
- The principal is the amount of money you have left to pay on your mortgage loan.
- The interest is the percentage of the principal you agreed to pay for the mortgage. It’s based on the amount of the principal and your mortgage rate. As you pay down the principal, the amount of interest you pay each month decreases over the term of the mortgage.
- Mortgages typically have an escrow account in which money is set aside to pay other costs associated with your mortgage. Homeowners insurance and mortgage insurance payments may be included in your mortgage payment. The lender will place cash for premiums into the escrow account and make payments for you to the insurance company when they are due.
- Property taxes may be included in your mortgage payment and placed in the escrow account.
Mortgage insurance protects the mortgage lender if you default on mortgage payments. As the borrower, you are responsible for paying for mortgage insurance, but the lender collects the money if it should pay out.
Even if you pay for mortgage insurance, you may still have to pay off your mortgage if you default on your loan. This means, the lender could foreclose on your mortgage — and you could lose your home — if you get too far behind on your mortgage payments.
Mortgage insurance differs from mortgage life insurance, which pays off your mortgage should you die. It also differs from mortgage disability insurance, which pays off the mortgage if you become disabled and can no longer work.
Types of Mortgages
There are several different types of mortgages available. These include private and government loans.
Each type of mortgage may be better suited for a particular type of home buyer based on your financial situation or other eligibility requirements.
When shopping for a mortgage, you should consider which type is best for you.
- Adjustable-Rate Mortgages
- The fluctuating interest rates of an adjustable-rate mortgage can cause uncertainty in the future. But if you are only planning to stay in your home for less than the time of its fixed-rate term, this might be a good choice.
- Fixed-Rate Mortgages
- If you want a predictable monthly payment — especially if you hold strictly to a budget — a fixed-rate mortgage will give you stable monthly mortgage payments.
- Conventional Loans
- Conventional loans are not backed by the federal government, but these can be the best choice if you have a good credit score. They come in conforming and nonconforming packages. Conforming loans meet Federal Housing Finance Agency (FHFA) guidelines — but these limit the amount of the loan. If you are looking for a more expensive home, or have gone through a major financial problem in the past, a nonconforming version may be a better option.
- FHA Loan
- This is a government loan designed for low- and moderate-income home buyers. A Federal Housing Administration (FHA) loan requires a lower minimum down payment, and you can qualify for it with lower credit scores than required for some other mortgage loans.
- Interest-Only Loans
- These are less common since the housing market collapse of the early 2000s. They involve complicated payment plans and are best suited to highly knowledgeable borrowers.
- Jumbo Loan
- A jumbo mortgage falls outside the FHFA limits. They’re more common in areas with high costs of living and typically require a lot more documentation to qualify. But these may be best if you have top-of-the-line credit and plan to buy an expensive home.
- Reverse Mortgages
- A unique product for people 62 or older who already own a home, reverse mortgages let people convert equity in their house into cash. The homeowner receives a lump sum with the balance coming due when you die or sell the home.
- USDA Loan
- There are several types of home loans available through the U.S. Department of Agriculture. These are zero-down-payment mortgages, but you must meet certain eligibility requirements. USDA loans are a possibility if you have a lower credit score, not much money for your down payment and meet other requirements.
- VA Loan
- The U.S. Department of Veterans Affairs may provide home loans to service members, veterans and eligible surviving spouses. The loans are provided through private banks and mortgage companies. It may be a good option if you don’t have much money for a down payment, a lower credit score and meet the VA’s eligibility requirements.
Applying for a Mortgage
While there are several steps you need to take when buying a house, applying for a mortgage has its own set of steps.
- Get your financial house in order.
- Check your credit score.
- Check your spending.
- Adjust your budget.
- Determine how much house you can afford.
- Use it to budget your down payment.
- Decide if it’s the right time for you to buy.
Compare mortgage offers.
- Get loan estimates from multiple lenders.
- Review and compare estimates.
- Choose the best mortgage offer.
Close on your new home and mortgage.
- Submit documents for approval of your loan.
- Choose the closing service providers you need for closing.
- Close the deal — sign the papers on the home and the mortgage.
You’ll first need to determine if you can qualify for and afford a mortgage loan. This means checking your credit score, reviewing your monthly budget and considering how you can adjust your current spending, if necessary.
Next, you will need to get pre-approved or pre-qualified for a mortgage. This won’t be an actual mortgage, but a letter telling sellers how much of a mortgage you would qualify for. This will help you determine how much house you can afford. You’ll still have to apply for a mortgage when you find the home you want to buy.
This may also be a good time to shop for the best mortgage deal. Compare mortgage rates from several different lenders and know where to find the best option for yourself.
Once you and the seller have settled on a price, you’ll be ready to close on a new home. Closing involves signing the paperwork that transfers the home to you and finalizes your mortgage contract with the lender.
10 Cited Research Articles
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- Maxwell, T. (2022, January 10). Here’s How Much a $100,000 Mortgage Will Cost You. Retrieved from https://www.foxbusiness.com/personal-finance/100000-mortgage-payment
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