A Beginner’s Guide to Mortgages

When looking for the perfect home most people consider the neighborhood, the number of bedrooms, bathrooms and all of the nice touches that distinguish it from the slew of other homes available on the market. Traffic commutes and other lifestyle choices can easily consume potential buyers during this process. However, there’s a key element that is often overlooked during the homebuying fiasco. How are you going to pay for your dream home? One key word: mortgages. By definition, a mortgage loan is a legally binding agreement between a borrower and a bank lender or financial institution. This loan is used to purchase real estate for the borrower in exchange for monthly payments plus interest. Let’s take a deep dive into some important things to educate yourself on before signing the dotted line.

Calculate how much you can afford comfortably.

This is an important component that many potential homeowners don’t spend enough time on, resulting in purchasing a home they’re not able to realistically afford. The amount the lender approves is not the amount you must use in full. Purchasing a home under budget gives you more leeway to budget for normal household expenses, repairs and other life occurrences. Remember, employment statuses can change, families have the ability to grow quickly and emergencies can regularly happen. Making sure you’re most prepared for all events reduces financial anxiety.

Shop around for mortgage interest rates.

A small difference of 0.5% has the ability to decrease or increase the homeowners’ loan amount tens of thousands of dollars. One of the main determining factors in ensuring the best possible rate is having a solid credit score. Taking the time to clean up any discrepancies prior to house shopping can save you the hassle of attempting to do this simultaneously while guaranteeing a better interest rate. Contact several lenders after the cleanup activity has been completed. Consulting with a mortgage broker can also assist to find the best rate possible.

Obtain a pre-approval from a financial institution.

This process differs from the pre-qualification, as this only provides a rough estimate of the total amount you’re able to borrow from the lender. A pre-approval requires a mortgage application while also running a credit check and employment verification. Be sure to complete this after shopping around for the best interest rate.

Understand the difference between a fixed rate and adjustable rate mortgage (ARM).

Interest rates are a very vital component of understanding the total amount of your monthly mortgage payment. A fixed interest rate remains the same throughout the life of the loan term, while an adjustable rate remains fixed for a predetermined amount of time (typically five years) – then adjusts periodically thereafter. What may be best for you can differ based on your personal situation. If you would like to lock in an interest rate while having a predictable mortgage payment, the fixed rate is the most viable option. If you are certain this home isn’t your forever palace and is a short-term stint, an adjustable rate could work. This option generally has a lower rate but has the ability to influx at any time based on the market.

Research all mortgage terms.

The most common mortgage is a 30-year payoff schedule; however, a 15-year term is also available. Naturally, a 15-year term requires a higher mortgage payment monthly but can take half of the time to pay off while securing a lower interest rate. Terms such as 10, 20 and 40-year are also available but may not be offered by all financial institutions. There are a lot of free resources online where you’re able to calculate which option is best suitable. While this doesn’t replace professional advice, this can provide a ballpark range to help aid in your final decision.

Determine which mortgage is best before house hunting.

There are a number of mortgages options, take a look at a few below:

Conventional: This is the standard mortgage that isn’t insured by the federal government. There are two types, conforming and non-conforming. A conforming loan amount has maximum limits set by Freddie Mac or Fannie Mae, the government agencies that back most of the U.S. mortgages. This type can be used for a primary residence or an investment property. A major benefit to this type is the down payment can be as little as three percent, giving more flexibility to your pockets. The minimum FICO score required is 620, so this option is best for those with stable income and solid employment history. A type of non-conforming loan, also known as a jumbo loan, is available when home prices exceed federal loan limits. If you’re looking to purchase a home in a more affluent area, this could be the option for you. A larger down payment, fairly low debt-to-income ratio and additional documentation is often required to qualify.

Federal Housing Authority: Also known as an FHA loan, this loan can help individuals who may not have a large down payment. A minimum FICO score of 580 qualifies for a 3.5% down payment, while a 500 can be accepted with at least a 10% down.

U.S. Department of Agriculture: USDA loans are for those that wish to purchase a home in a rural area. This has a few stipulations, as it must be in a USDA-eligible area and certain income limits to qualify.

U.S. Department of Veterans Affairs: VA loans are exclusively offered for active duty personnel or veterans and their families. This loan doesn’t require a down payment or private mortgage insurance (PMI), and closing costs are typically capped.

Determine the best down payment amount.

The industry standard is typically 20% of the purchase price but is certainly not mandatory.  If you are very early in the home process, continue to stow away money to potentially reduce your overall monthly mortgage payment. Be sure to avoid wiping out your savings completely, as life must continue after the purchase of your home.

The more informed you are before purchasing, the more prepared you’ll be to confidently make the best, sound decision for you and your family. Don’t be afraid to ask questions as standards, rates and the climate of the home market changes frequently.