Curious about mortgage loans? Wondering about the cost of a down payment? Not sure where to begin your mortgage shopping journey? Uncover these insights and more in our in-depth guide to understanding mortgage loans!
For first-time home buyers, the thought of securing a mortgage loan can be overwhelming. With so many options on the market, what type of mortgage is right for you? In this comprehensive guide, we’ll break down the essentials of what a mortgage is and explain each step toward securing your first home loan, so you can enjoy the process of being a first-time homebuyer!
What is a Mortgage, and What are the Four Essential Elements?
A mortgage is a loan from a lender, usually a bank or mortgage company who specializes in residential loan financing, to buy a home. The property acts as collateral that the lender can claim if you fail to repay the loan. A mortgage acts similar to an auto or RV loan, where the car or recreational vehicle is set as collateral for the loan.
A mortgage consists of four essential elements: P-I-T-I
Principal: The actual amount of money you borrow, excluding interest and other additional fees. As you pay your mortgage each month, a part of that payment goes toward your principal.
Interest: The cost of borrowing money that’s included in your monthly payment, calculated using your credit score, home price, loan amount, down payment, loan term, and loan type.
Taxes: Your property taxes are often included in your monthly payment. Your lender then keeps this money in an escrow account and pays it on your behalf when your tax bill is due.
Insurance: Most homeowners pay homeowners insurance through their monthly mortgage payments. This includes private mortgage insurance (PMI) required by lenders when you put down a down payment of less than 20%, as well as insurance required for government-backed loans.
Types of Home Loans
When shopping for a home loan, buyers have several options to choose from based on their specific circumstances. Let’s look at the four basic categories of loans.
Fixed-Rate Loans: The most predictable type of loan. The interest rate on this kind of loan remains the same for the entire duration of the loan, usually up to 360 months on a 30-year fixed-rate mortgage.
Adjustable-Rate Loans: Unlike fixed-rate loans, an adjustable-rate mortgage (ARM) changes based on fluctuating interest rates. The most common types of ARM loans are 3/1 ARM, 5/1 ARM, and 7/1 ARM, with your interest rate being set for three to seven years before readjusting annually.
Government-Backed Loans: Loans subsidized by the government, providing protection for lenders against defaults on payments. These loans tend to have high closing rates and lower interest rates. Examples include Federal Housing Administration (FHA) loans, Veterans Administration (VA) loans, and the U.S. Department of Agriculture’s Rural Development (USDA) loans.
Jumbo Loans: Loans that don’t meet the guidelines laid out by Freddie Mac and Fannie Mae regarding credit, income, and asset requirements. These require a lengthy qualification process but allow for much larger loans if you put down a significant down payment.
Non-QM Loan: Non-QM loans are designed to help homebuyers who cannot meet the strict requirements for typical lending products, often due to unique income situations. For example, a self-employed individual who cannot provide the required documentation or a borrower with a higher debt-to-income ratio may be better suited for a non-QM loan.
Here is more information on loan programs: FHA vs Conventional Loan Programs
How Much Mortgage Can You Afford?
Before you start house hunting, it’s crucial to determine how much you can afford to borrow. Keeping in mind PITI elements, it’s recommended that your monthly payment should be no more than 28% of your gross monthly income. Use our mortgage calculator tool to get an idea of what monthly mortgage payments might look like with different types of loans and term lengths.
Understanding Down Payments and Debt
A down payment is the portion of the home’s purchase price that you pay upfront. For conventional loans, a down payment of 20% or more is ideal to avoid paying PMI. However, some government-backed loans can offer financing with as little as 3.5% down, and even 0% down for USDA Rural Development, or Down Payment Assistance Programs offered through state housing agencies..
Before applying for a mortgage, assess your debt-to-income ratio (DTI). Your DTI compares your monthly debt payments to your gross monthly income. Ideally, your debt shouldn’t exceed 36% of your income, however in reality, this may be closer to 45% with today’s prices.
Here’s a related article on down payments: Why you don’t need a 20% down payment
How Do Credit Scores Affect Buying a Home?
A good credit score is crucial when it comes to securing a mortgage. Lenders use your credit score to determine how risky it is to lend you money. A low score indicates higher risk, which translates to higher interest rates. Before you start applying for mortgages, work to improve your credit score.
What is Private Mortgage Insurance (PMI)?
PMI is a type of insurance that protects the lender in case the borrower defaults on the loan. PMI is typically required if your down payment is less than 20% of the home’s purchase price. It can cause your monthly mortgage payment to increase by a few hundred dollars, so considering putting down a larger down payment or finding a loan that doesn’t require PMI could save you money in the long term.
Calculating Closing Costs
Closing costs are fees and expenses associated with buying a home, such as appraisal, taxes, and title searches. Typically, closing costs can range between 2% to 5% of the loan amount. Make sure to factor closing costs into your budget when figuring out how much house you can afford.
How to Get Started Buying a House
To get started buying a house, there are several steps you can take:
- Get pre-approved for a mortgage before starting your house hunt. You can start that process online, or with a qualified Mortgage Loan Officer. We offer an easy online version. You can start that process below.
- Hire a real estate agent to help you find the right home for your budget.
- Make an offer on your desired property.
- Finalize your mortgage application with your lender and close on your house.
Pursue the Right Home Loan Option for You
Choosing the right mortgage takes time and careful consideration. Ensure that you understand your financial standing, budget, and goals before selecting a loan type. Armed with a good understanding of the mortgage process, you can confidently move forward and purchase your dream home.
More About Mortgage Insurance
Mortgage insurance is an essential part of the mortgage process, particularly for those who have a smaller down payment. Mortgage insurance protects the lender in case you default on your mortgage, and is required for any mortgage with less than a 20% down payment. Mortgage insurance can be paid in different ways, either with a one-time upfront payment or a monthly payment that’s typically added to your mortgage payment.
Let’s Talk Closing Costs
When you close on a property, there are certain fees you’ll need to pay to finalize your mortgage. In general, closing costs can range from 2-5% of your total mortgage. These fees allow for the transfer of ownership of the property and ensure that everything about the transaction is done lawfully. The exact fees you may pay depend on various factors such as your bank, your mortgage type, and your location.
Applying for a Home Loan
Before you start applying for a home loan, you’ll need to have a few things in order. You should be prepared to provide information about your income, debts, and assets. Your credit score can significantly impact your mortgage rates and ability to qualify for certain loans. Once you have all this information, you can officially apply for a mortgage with a lender.
Important Note: Your Mortgage Loan Officer can provide you with insights and additional information on optimizing your credit, once your application is submitted. So if there is anything that needs to be addressed before buying, that can be very helpful in your success.
The Importance of Working with an Experienced Mortgage Lender
Working with an experienced mortgage lender can make all the difference throughout the mortgage application process. Mortgage Lenders can help you find the best mortgage for your specific needs. Find someone local, with an established business, and good customer reviews.
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The Importance of Working with an Experienced Realtor
A competent real estate agent is a valuable asset when you’re buying your first home. They can help you find a home that fits your needs and budget, negotiate the price, and guide you through the closing process.
Often times your Mortgage Loan Officer can refer you to a local Realtor they trust to guide you through the process. Having your Realtor and Lender working together can make all the difference in the world to the success of buying your first home. This is also a benefit to working with local professionals, and not using online lenders.
Here is an article on Realtor Fees: How are Realtor Fees Paid
Always have a professional Home inspector inspect the home before you buy it. They can spot problems that you may not notice, potentially saving you thousands of dollars in the future. You can also use the home inspection as a roadmap to needed updates and upgrades you may want to do in the future.
The Bottom Line
Securing a home mortgage can be daunting for first-time buyers. However, with the right knowledge and guidance, it doesn’t have to be.
Remember that there are many types of mortgages available to you, and finding the one that fits your needs is crucial. Factors such as your credit score, down payment, and income will all play a role in the mortgage process. However, by working with experienced professionals and arming yourself with the right knowledge, you’ll be well on your way to homeownership in no time.
Frequently Asked Mortgage Questions:
What exactly is a mortgage?
A mortgage is a loan for buying a home. The home is put as collateral for the mortgage in case of default. Its four elements include Principal (loan amount), Interest (borrowing cost), Taxes, and Insurance (P-I-T-I).
What are the different types of home loans?
Home loans types include Fixed-Rate, Adjustable-Rate, Government-Backed, Jumbo, and Non-QM Loans, each serving different borrower needs. Several terms are available from 30,20,15, and 10 years on typical loan programs.
How much house can I afford?
You should ideally keep your mortgage payment between 28%-35% of your gross monthly income. A mortgage calculator can provide a rough estimate of what size loan you could potentially qualify for. You can always speak with a Mortgage Loan Officer as well.
What is a down payment and how much should it be?
A down payment is the upfront portion of the home’s price. Ideally, it’s 20% for conventional loans but can be as low as 3.5% for some loans. USDA Rural Development even offers 0% down payment options.
What credit score is good for buying a house?
A good credit score for buying a house typically starts at 670, according to the FICO score range. However, a score of 740 or above could get you the best interest rates. Lenders may have different requirements, so it’s best to check with them directly.
What is Private Mortgage Insurance (PMI)?
Private Mortgage Insurance (PMI) is a type of insurance that lenders require from homebuyers who obtain loans that are more than 80% of their new home’s value. In the event of a default, PMI protects the lender. Once equity reaches 20%, homeowners can typically request to cancel PMI.
How are closing costs calculated?
Closing costs, fees tied to home buying, range between 2% to 5% of the loan amount. Factor these into your budget when considering affordability. Often times, these can be negotiated and paid by the Seller of the home you are buying.
How should I get started on buying a house?
Start by assessing your financial situation, including credit score, income, and savings for a down payment. Next, get pre-approved for a mortgage to understand your budget. Then, research neighborhoods and hire a real estate agent. After finding a house, make an offer, get it inspected, and close the deal.
Get started on your journey today!
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