For most people, buying a home is the biggest purchase of their life. Unless you pay cash, chances are you will acquire a mortgage to pay for the home. Simply put, a mortgage is a loan used to pay for the property, with your house used as collateral.
Several types of loans exist, each with distinct terms and conditions. Let’s take a closer look at some basic mortgage information.
How do I apply for a mortgage?
Before you make an offer on a house, most Realtors will ask you to fill out a loan pre-application form. Through this process, you will become acquainted with your mortgage broker, submit preliminary income statements and learn how large of a loan you qualify for. This step is important because it will give a clear idea of how much house you can buy.
Once you find a house you like and enter into a contract to purchase the home, your mortgage broker will work with you and loan underwriters during escrow — typically 30 days — to finalize funding. The broker will typically need more definite income statements, and may wish to talk with your employer to verify information. Once the loan is funded, the home becomes yours. However, because your home is collateral for the loan, the bank can take your home if you fail to make payments.
What types of mortgages are there?
Fixed-rate mortgage: These mortgages feature loan payments that stay the same amount over the course of the loan. Terms for fixed-rate mortgages usually last for 15 or 30 years. With a 15-year loan, you’ll have a higher monthly rate, but pay less interest overall. These loans usually don’t have early payment penalties, which means you can pay your loan off early without incurring an additional fee.
Adjustable-rate mortgage: These mortgages, also known as ARMs, include interest rates that change over time. They frequently offer low, introductory payments, but the interest rate may rise over time. It’s tied to an index comprised of factors both market- and lender-driven. When the interest rate increases, your payment also increases. These mortgages gained fame during the mortgage meltdown that preceded the Great Recession because many people found it difficult to afford the higher payments once the interest rate increased. Sometimes, these loans do incur early payment fees.
ARMs can be useful if you don’t plan to own your home for a long time, and you want to take advantage of those early, lower payments. However, carefully consider the risks and read all the fine print before taking on one of these loans.
Reverse mortgages: Seniors who want to access their home equity without selling their home and moving acquire these mortgages. To qualify, a person must be at least age 62. There is a specific calculation used by banks to determine how much equity will be required to receive a reverse mortgage, if the homeowner does not own the home free and clear. The money can be used for living expenses, medical bills or to supplement Social Security. Most of the time, whoever inherits the home repays the loan — not the person who acquired it.
What does a mortgage payment include?
Each payment includes at least two different portions. Interest goes directly to your lender as profit. Principal goes directly to the amount you owe on your house.
Another portion of the loan may go toward a mortgage insurance premium, if applicable. Mortgage insurance is typically found on government-backed loans in which the buyer puts less than 20 percent down. The lender, to insure the mortgage since the buyer has little skin in the game, requires the buyer to purchase mortgage insurance.
Mortgage payments also include your property taxes, so you don’t need to worry about your tax bill until you own the house free and clear — meaning the loan is paid off.
Mortgages do not include other fees, such as those imposed by home ownership associations.