Home Mortgage Basics

by Nancy

Buying your first home is scary, but it doesn’t need to be if you do a little research and understand the basics.   A mortgage is simply a loan that is used to buy your home.

Mortgages are useful because very few people have enough cash on hand to pay the entire cost of a house.  To qualify for a mortgage, you must meet the minimum standards of whichever loan type you determine best meets your needs. This often includes meeting minimum credit score requirements, income requirements, and debts.

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.

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 loan type is different, with varying 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 down payment 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.

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.