Right now, people are buying homes like they’re going out of style. But, if you don’t have the ability to buy a home at cash value, you’ll have to take out a mortgage. What is a mortgage? Great question. In this blog we’ll go over different types of mortgages, how to obtain one, and what monthly mortgage payments are.
To understand mortgages, you need to know common terms that are used with the process:
- Borrower: a borrower is the person who is taking out the mortgage loan. They are borrowing money from the bank, credit union, or mortgage loan companies.
- Co Borrower: This is for when there are two people who filed. Both of the incomes, assets and credit histories are utilized to qualify for the loan. Both are equally responsible for mortgage payments and ownership over the property. It is not a requirement to have more than one person listed on the mortgage, but it strengthens the chances to qualify for a larger mortgage. This could be a spouse, family member, or friend.
- Lender: the mortgage lender is the financial institution or organization that gives loans for real estate purchases. The lender evaluates the financial condition of the borrower and assesses any risks they could present on repaying the loan.
What is a Mortgage?
Mortgages are loans used by individuals and businesses to purchase real estate without having to foot the entire cost of the estate at once. Instead, mortgage loans are taken out! They are paid out through a specified number of years (think 15 or 30 years). The loan is in place until the borrower has paid back the loan and owns the property on their own. These loans are also called “liens against the property,” meaning that if the borrower decides to stop paying monthly payments, the lender can foreclose the property. Foreclosing means that the bank takes ownership of the property and sells it as collateral for the loan amount. Additionally, the residents are evicted.
Think of a mortgage like an agreement between you and the lender, where if you don’t make your payments, the lender has the right to take the property. There are important factors that you want to keep in mind when searching for a mortgage.
- The size of the loan you’re taking out
- What the interest rate is
- The Annual Percentage Rate (APR) is
- What type of interest rate it is (example: is it a fixed interest rate or is it adjustable?)
- The closing costs of the loan and if there are lender’s fees
- How long the loan term is and how long you have to repay it
- Any risky clauses, such as a prepayment penalty, balloon clause, or negative amortization
- Focus on how much you can afford to pay, not the highest amount you can qualify for.
The Process to Getting a Mortgage
To get a mortgage, you’ll need to qualify for it. The lenders have a process in order to find out the amount of money that they’re willing to loan out. So what is a mortgage lender looking for? These qualifications include your income, any debts, the percentage for your down payment and credit score. Additionally, they use that information to judge how risky of a candidate you are. The riskier someone is, the higher their interest rate becomes.
Let’s break these qualifying factors down.
Your Income
The income of the borrower or borrowers has a huge impact on how much you can be qualified for. Lenders will require documents like a W-2 to prove job stability and other verifications of income and hire date. Additionally, they will want to see previous tax forms to see history of income.
Debt to Income Ratio
This is the total between your monthly debt payments divided by a gross monthly income. This gives lenders the insight of your ability to manage your funds while simultaneously paying off borrowed money. The Consumer Financial Protection Bureau recommends that your debt to income ratio is no more than 43%. Their recommendation is that due to it being the average highest amount that lenders will allow while applying for a mortgage. Again, the higher that number is, the riskier the lender sees the borrower. This can lead to increased interest rates.
Down Payment
A down payment is the amount of money you’re putting down while buying a house. This is the upfront money. The higher your down payment is, the lower your monthly payment will be for your mortgage. There are a few different options for what your down payment can look like. The rates are indicative of the type of mortgage you have, so different rates require a different percentage for a down payment. Additionally, things like a credit score can also affect the amount that needs to be paid upfront.
Nerdwallet lists these rates for a first time homebuyer:
- Fair Housing Administration (FHA) loans require as little as 3.5% down
- Veterans Affairs (VA Loans) usually don’t require down payments. However, this loan’s availability is towards current and veteran military service members or eligible surviving spouses.
- USDA Loans also have no down payment requirement. This loan offers programs for rural and suburban homebuyers that meet their criteria.
- Conventional mortgages can require as little as 3% down
You might be wondering: I thought that 20% was the average amount? Surprisingly… Not anymore. According to Rocket Mortgage, the average is now at 6% down. So why don’t more people go for a lower percentage? Well, when you put 20% or more down, you’re avoiding paying mortgage insurance. This is an additional cost every month, leaving homebuyers with a larger monthly payment. We will get into mortgage insurance later, so hold onto that idea for now.
Credit Score
The lenders see your credit score as a reflection of your financial history. The higher the credit score is, the lower your interest rate and mortgage payment is. Before you start the process of finding a mortgage, consider doing individual research to see what your credit score is and see if there are any negative factors that can be disputed and removed. Most lenders have minimum qualifications like the following:
- Minimum of 620 for a fixed-rate or adjustable rate mortgage
- 580 for minimum down payment of a government-backed loan (VA)
- 500 for a government backed loan with a higher down payment of at least 10%
The Monthly Payments
Part of having a mortgage includes monthly mortgage payments. You’ll hear this payment referred to as PITI. PITI stands for principal, interest, taxes and insurance. Then, the principal becomes a portion of the loan paid out every month. The interest is the accrued charge chosen by the lender and mortgage that was chosen. For example, the average rate of interest for mortgage loans in 2020 was 3.72% on a 30 year fixed rate. Then, you’re going to pay taxes.
Every monthly payment includes 1/12 of the yearly property tax rate based on the neighborhood. Lastly, you’re going to have a charge for insurance. Lenders require homeowners insurance in order for them to agree to lend you money. The borrower is making an investment in the house, but the lender is making an investment in the house, too. That means providing home insurance against hazards like fire, theft, accidents, or severe weather.
What Is A Mortgage Insurance Used For?
Consumer finance lists mortgage insurance as the following: borrowers making less than a 20% down payment will need to pay for mortgage insurance. This is also required on FHA and USDA loans. This lowers the risk to the lender, qualifying you for a loan that you ordinarily would not qualify for. Remember, all lenders see borrowers as some form of a risk, so the insurance continues to protect them if you were to fall behind on your payments. However, this does increase the cost of your loan, thus increasing monthly payments to the lender and closing costs.
Types of Loans Affecting Mortgage Insurance
The type of loan you have also makes an impact on your mortgage insurance. Here are the most common loans and what to expect with mortgage insurance:
- Conventional loans could require the lender to arrange the insurance through a private mortgage company. Those rates will vary due to the down payment amount and credit score. This is paid monthly with little to no payment required at closing.
- The US Department of Agriculture Loan (USDA) requires paying for insurance at closing and a recurring monthly payment. Additionally, this loan allows you to have the upfront portion of your insurance premium into your mortgage, rather than paying it out of pocket. As a result, both your loan and overall costs increase.
- Federal Housing Administration (FHA). If your mortgage insurance premiums are paid to the FHA, then you’ll have to have an FHA mortgage insurance. No matter your credit score, the prices will never vary. The FHA mortgage insurance includes upfront costs paid with your closing cost and a monthly cost. Additionally, you are able to pay the initial fee into your mortgage payment and increase monthly costs.
- (Veterans’ Affairs) VA Loans: This form of loans is intended to assist servicemembers, veterans and their families. Due to this, there is no monthly mortgage insurance premium. There will be a funding fee which varies on type of military service, down payment amount, disability status, buying or refinancing, and whether or not it’s the first VA loan the borrower has taken out. Like the USDA and FHA loans, you’re able to roll the upfront fee to be included in the monthly payment.
