Buying a home and tackling financial responsibility is often a goal for many. However, taking this giant leap to homeownership can be overwhelming and should be taken with careful consideration. After all, finding the home of your dreams and securing a mortgage isn’t a cakewalk, and definitely not as easy as signing a rental agreement.
If it’s your first time getting a home mortgage, you might have probably encountered confusing terms like ‘points,’ ‘prequalification,’ and ‘preapproval,’ and also funny names like Fannie Mae. Furthermore, there are also various mortgage options out there—your bank, independent mortgage brokers, a credit union, and online lenders, who would all want to sell you a home mortgage. But remember, they are trying to sell you something because whoever you choose to get the mortgage from will be making money off you.
For this reason, it’s always better to go into your conversations with lenders with an understanding of a few essential terms. Below, you will find the basics of mortgage and concepts that will help you steer clear of frustration.
What Is A Mortgage?
Buying a home will perhaps be one of the largest and most important purchases you will make in your life. Thus, as a first-time homebuyer, it is important to make sure you understand how the home buying process works and what you can expect from your mortgage.
To put it short, your mortgage is a loan that you will use to purchase your home.
Much like other loans, with mortgages, there is an amount borrowed, a rate of interest the borrower should pay the lender, and a predetermined number of years over which the loan must be repaid.
However, the key factor that differentiates a mortgage from the other loan types is that a mortgage loan is specifically focused on real estate purchases. Additionally, mortgages can also be customized.
Presently, there are many loan programs available for homebuyers, including loans for buyers of condominiums, low- and zero- down payment loans, and loans for the U.S. military members. Your mortgage lender will help you find the loan that best fits your needs.
How Does a Mortgage Differ from a Loan?
The term ‘loan’ refers to any financial transaction where one party borrows a lump sum and agrees to pay the money back. On the other hand, a mortgage is a type of loan used only to finance a property. In other words, all mortgages are a type of loan, but not all loans are mortgages.
Furthermore, mortgages are secured loans. When it comes to a secured loan, the borrower promises collateral to the mortgagee in the event they stop making payments. In the case of mortgages, the collateral is your home. If you stop making timely payments on your mortgage, your lender has the right to take possession of your house through a process called foreclosure.
Types of Mortgages
Home mortgages come in various forms. The most popular mortgage types have a fixed repayment term of 30 or 15 years. Nevertheless, some mortgages can also be as short as five years, while others can be 40 years or longer. Stretching your repayment term reduces the monthly payment but increases the amount of interest you will pay.
Below listed are two primary mortgage types you should know of:
- Fixed-Rate Mortgage
With a fixed-rate mortgage, the borrower will pay the same interest for the entire repayment term. The monthly principal and interest payments don’t change from the first mortgage payment to the last.
Even if the market interest rate rises, the borrower’s payment doesn’t vary. On the other hand, if the interest rates drop significantly, the borrower can refinance the mortgage and secure the lower rate.
Generally, a fixed-rate mortgage is what is referred to as a ‘traditional’ mortgage.
- Adjustable-Rate Mortgage (ARM)
With an adjustable-rate mortgage (ARM), the borrower will pay a fixed interest for an initial term, after which the interest rates will keep varying with the market interest rates.
The initial interest rate is often a below-market rate, which is what makes this mortgage type more affordable in the short term but less affordable in the long run.
For instance, if the interest rates increase later, the borrower might not be able to afford the higher monthly payments. Nonetheless, the interest rates could also decrease, making the ARM less expensive. In either case, the monthly payments remain quite unpredictable after the initial term.
Other common types of mortgages include payment-option ARMs and interest-only mortgages. These often involve complex repayment schedules and ideal for sophisticated borrowers. According to studies, many homeowners in the early 2000s got into financial trouble with these types of mortgages during the housing bubble.
Lastly, most home mortgages are forward mortgages. There also exist reverse mortgages, specially designed for homeowners aged 62 or older who are looking to turn part of the equity in their homes into cash.
Here’s how it works—a homeowner borrows against the value of his/her home and receives the money as a lump sum, line of credit, or fixed monthly payment. The entire loan balance becomes due and payable only when the borrower permanently moves away, sells the house, or dies.
Finding the Right Mortgage
There are numerous banks out there on the market that offer mortgage loans, including major banks like Bank of America, JPMorgan Chase, and Wells Fargo. Many years back, banks used to be the only source of home mortgages.
However, today there is an extensive array of mortgage lenders on the market, including non-banks such as Quicken Loans, SoFi, United Wholesale Mortgage, and Loan Depot.
When shopping for a mortgage loan, always use a mortgage calculator to figure out the monthly payments beforehand. This tool will also help you calculate the total cost of interest you will pay over the life of your mortgage. Meaning, you will have a clear idea of what a property will actually cost.
Sometimes, your mortgage servicer might also help you set up an escrow account, also known as an impound account, to help you pay off certain property-related expenses.
All the money that goes into these accounts will come from a portion of your monthly mortgage payment. Occasionally, lenders will require that you use the escrow to pay taxes and insurance, according to the U.S. Consumer Financial Protection Bureau.
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