Millions of homes are sold each year. In 2019 alone, Americans bought more than 5 million homes.
Buying a home isn’t possible for most people without the help of a mortgage. What is a mortgage loan?
It’s likely you’ve heard the term, but aren’t sure exactly how it works. Check out this guide to mortgages for first-time buyers.
What is a Mortgage Loan?
Mortgages are paid monthly much like a rent payment, but that’s where the similarities end. A mortgage is a loan used to purchase real estate.
Since most buyers can’t afford to pay the total cost of a house using cash, mortgage lenders offer loan products to help them make the purchase. Mortgage lenders range from private companies to major banks.
Without the help of a mortgage loan, very few Americans could become homeowners. Mortgages are offered in amounts that exceed what most people can quickly repay.
Standard repayment terms are 15 and 30 years. This means a homeowner has 15 or 30 years to pay back the debt.
You have the option to shop for specific loan products that match the terms you prefer. Here are some of the common types of mortgage loans.
Conventional Mortgages
Conventional mortgages include any mortgage that isn’t insured by the federal government. Buyers bring around 20 percent of the purchase price to the closing table to avoid paying private mortgage insurance (PMI).
If you can’t afford a 20 percent down payment, you’ll be charged PMI which results in a higher monthly mortgage payment. But once the equity in your home reaches 20 percent, you can request to have the PMI removed.
Expect to provide lots of financial documentation on these loans. Since they’re not insured by the government, mortgage lenders have to be especially careful to only lend to buyers who can afford to repay.
Adjustable-Rate Mortgage
The benefit of an adjustable-rate mortgage (ARM) is that the interest rates are often very low in the first few years of owning a home. But these rates are subject to change according to market conditions.
ARM mortgages are worth it for people who might not plan to stay in their homes for the entire mortgage term. These mortgages may not be the best option for first-time buyers since they require an understanding of how a sudden change in interest rates could affect your monthly mortgage payment.
Fixed-Rate Mortgage
Fixed-rate mortgages keep the same interest rate over the life of the loan. These loans typically last 15, 20, or 30 years.
The main advantage of a fixed-rate loan is knowing exactly how much your mortgage payments will be each month. The downside is that if interest rates are high when you apply for a mortgage loan, you’re stuck with this rate until you can refinance.
Jumbo Mortgage
If you’re looking to buy a home above $500,000, you’ll need to get a jumbo loan. Jumbo loans allow you to buy homes in expensive areas or markets.
It doesn’t matter whether you’re buying a luxury property or live in a city with inflated home prices, jumbo loans make it possible to pay for higher-cost properties. These mortgages are riskier than conventional mortgages so you’ll need a higher credit score and a low debt to income ratio.
Key Things to Know
Understanding how mortgages work helps prevent future financial setbacks. Mortgage education also means having control over how long it takes to repay your loan.
Here are key things to know about mortgage loans.
Amortization
A mortgage loan consists of two important parts: principal and interest. The principal balance is equal to the amount you pay for your home.
Mortgage interest is what the lender makes in profit from lending you money to buy the home. Interest is applied to the principal balance according to an amortization schedule.
This schedule is important because it helps lenders guarantee their profits, but can also be used by borrowers to pay down a mortgage loan faster. Part of each mortgage payment goes toward the interest and the other goes toward the principal balance.
In the beginning of your loan term, most of your monthly mortgage payment goes towards interest, while a smaller portion goes toward the principal. Lenders allow you to review your amortization schedule so you can see how your payments are divided throughout the life of the loan.
Down Payment
Down payments are an important thing to consider when buying a home. Fannie Mae and Freddie Mac home buying programs allow homeowners to put down less than conventional mortgage loans.
Expect to put down between 3 percent and 20 percent toward the purchase price of a home. This is the amount you’ll bring to closing as certified funds.
Some loan programs allow you to use retirement accounts as a down payment without an early withdrawal penalty. Paying a 20 percent down payment is beneficial because it means being able to skip private mortgage insurance.
Escrow
Being a homeowner comes with a set of annual expenses which include property taxes and insurance. To cover these costs, your lender might set up an escrow account that pays for these expenses for you.
The escrow account is managed by the lender somewhat like a checking account. This money isn’t a gift from the lender.
Each month, a portion of your mortgage payment is set aside in this account. If your lender doesn’t offer an escrow account, you can pay these expenses yourself in exchange for a lower monthly mortgage payment.
Benefits of Being a First-Time Home Buyer
What is a mortgage? Mortgages are loans used specifically for the purchase of real estate.
As a first-time homebuyer, you can be flexible in how you choose to make your down payment. You can also receive help from federal programs. Consult with a mortgage broker about the opportunities available to you at the state and federal level.
For more information or to get a quote, contact us today.