Mortgage Basics You Didn’t Know You Needed To Know

Remember the first time you started to learn algebra and wondered what the heck was going on, but then it clicked and became easier? You know that the more you educate yourself on a topic, the easier it becomes.

In the beginning, getting a mortgage can be an overwhelming process, but it’s the same as when you’re learning a new math formula. If you learn the basics, you’ll soon see that it’s pretty direct — you just need that background info to get you started. So, let’s get you informed and ready for your next big step into homeownership. This can truly be a fun and exciting time in your life!

Question: “What’s a mortgage?”

A mortgage is a loan from the bank to pay for a house. It’s a regular payment you owe for the life of the loan and includes interest on the money that was given to you. When you take out a mortgage, your house is now the collateral that the bank uses as their protection in case you start to miss your payments. If you don’t or can’t pay your mortgage, the bank reclaims your home as theirs and sells it to make their money back.

Question: “What’s included in a mortgage payment?

There are a few parts to a mortgage payment: the principal, interest and escrow. Even though the amount you pay each month doesn’t change, what makes up that amount does. The more you pay on your mortgage loan, the more your principal goes down. However, early on in the loan, more money that you pay is allocated to the interest portion than the principal. So, your interest amount will vary every time you make a monthly payment. Later in the life of the loan, these two will eventually flip.

Here’s an example of how principal and interest work into your monthly mortgage payment …

Based on a $100,000 mortgage, and an interest rate of 5%, a monthly payment would be $581.60. Let’s see how that breaks down over time:

  • Month 1, you pay $581.60
    • $412.39 goes toward interest; $169.21 goes toward principal
  • Month 2, you pay $581.60
    • $411.69 goes toward interest; $169.91 goes toward principal
  • Month 3, you pay $581.60
    • $410.99 goes toward interest; $170.61 goes toward principal

You can see that the monthly payment amount does not change, but the amount allocated toward interest shrinks with each payment, and the amount allocated toward principal increases. Once you pay off your mortgage, you own your home. Huzzah!

Escrow is another collection of funds that’s baked into your monthly mortgage payment. With an escrow, every time you pay your mortgage, some of it goes into a separate account for things like property taxes and insurance premiums. When taxes come due, they’re paid on your behalf with these funds. Done and done!

Question: “How often will I pay my mortgage?”

Though one payment each month is the most common option, you do have the option to pay your mortgage more often than that.

If you choose to pay weekly, this breaks what would be a monthly payment into 4 installments; and if you choose a biweekly option, this breaks that monthly payment into two installments. For example, based on our previous mortgage example, your monthly payment of $581.60 would be $145.40 if paid weekly, and $290.80 if paid bi-weekly.

These latter two options may put a bit more strain on your budget, as you will make an additional 1 -2 mortgage payments more per year compared to a traditional monthly payment, but you will end up paying off your mortgage loan earlier. Another huzzah!

Figuring out what’s right for you depends on your income and your lifestyle. Just note that when your mortgage is calculated, it will most likely be done so using the monthly payment model.

If you question when your first payment will come due, our quick video that will give you the answer.

Question: “What’s the difference between term and amortization?”

Term: The term of your mortgage loan is the amount of time, or how long you have to repay the loan. For most mortgage types, terms are 15, 20 or 30 years long.

Amortization: Amortization refers to the payoff process of your home loan. When you take out a mortgage, the lender creates a payment schedule for you. This schedule is many pages long because it’s broken-down month-by-month, year-by-year. If you have a fixed-rate mortgage, you will see consistent equal installments throughout the life of your loan. However, no matter what type of loan you choose, you should request an amortization schedule to ensure you are allowed to pay off your loan early if you choose to do so.

Learn even more mortgage terminology before you get to the closing table in this video.

Question: “What different type of mortgages are out there?”

  • Conventional
    • Conventional mortgages have strict guidelines on those who can qualify, but they often offer better interest rates by about .25 or .5 of a percent. The guidelines for a conventional mortgage are set by Fannie Mae and Freddie Mac and include the following:
      • The mortgage loan amount needs a down payment of 3 – 20%+
      • Your loan to value ratio (commonly referred to as LTV) needs to fall within a certain range.
      • You must have a minimum credit score of 620.
      • You may have to have private mortgage insurance (PMI) until you reach 22% equity in your home.
    • Federal Housing Administration (FHA)
      • FHA loans have more flexible lending requirements than conventional mortgages, but you will typically find a higher interest rate paired with these loan types. The credit score requirements are not as high as a conventional mortgage, and your down payment can be lower (as low as 3.5% if you have a credit score of 580 or higher).
      • However, you may be required to pay a mortgage insurance premium in addition to your monthly mortgage payments with this type of loan.
    • Veteran Affairs (VA)
      • VA mortgage loans are ones that are backed by the Department of Veterans Affairs. A VA loan is only available to military service members and veterans. The huge draw to those who qualify for one is that it typically has a low interest rate, there’s no down payment required, no cap on how much you can borrow, and there will be no mortgage insurance tied to the loan. You qualify for a VA loan if you are a spouse of a service member who died in the line or duty or because of a related injury. You also qualify if you’re an active or retired member of the armed forces with at least:
        • 90 days of consecutive service during wartime.
        • 181 days of service during peacetime.
        • 6 years of service in the national guard or reserves.
      • Fixed Rate
        • These are often 15 or 30-year-long mortgages where the interest rate stays the same for the entire life of the loan. This is ideal for those who can lock in a good rate and want to stay in their home for a longer amount of time. It brings peace of mind always knowing your loan amount.
      • Adjustable-Rate Mortgage (ARM)
        • ARMs are often 30-year-long mortgages. The first portion of the mortgage has a fixed rate, but after, that it’s adjusted periodically. For example: you have a 5/1 ARM. The first number, 5, indicates how long the rate will be fixed for, and the second number, 1, indicates how often the rate will adjust thereafter (1, or once per year).
        • Because most people don’t stay in their first home for more than 10 years, you can benefit from the advantage of an ARM rate being lower and build more equity in your home before you sell.

Question: “What are mortgage points?

Mortgage points are loan discount points that allow you to prepay interest. 1 point = 1% of the loan. Paying for points allows you to decrease the interest rate of your loan, but they cost money up front. Depending on how long you plan to stay in your home will help you decide their worth, because it takes time to make the money back that you spend on points. Your options on the cost of points will vary from lender to lender.

Question: “What’s APR?”

The annual percentage rate, or APR, accounts for the costs of producing a loan — not just the loan amount itself. It’s a broader, more holistic view of the annual cost of the money that you’re borrowing. The additional costs included in your APR are dynamic, because they’re set by the lender and include:

  • Mortgage insurance
  • Broker fees
  • Origination fees
  • Discount points
  • Closing costs
  • And underwriting fees

An APR is the yearly cost of borrowing money, and because it also includes the interest rate, your APR will often be higher than the interest rate itself. Line items like closing costs can vary by lender, so give the APR that you’re offered attention, as you could be offered the same interest rate by several different lenders, but they may all offer different APRs, meaning potentially more costs in fees. And here’s the caveat: The Truth in Lending Act requires lenders to disclose a borrower’s APR, however, some costs like the pulling of your credit report, appraisal fee and inspection fee are not required to be reported in the APR. When you’re comparing offers, you’ll want to ask your lender what’s specifically included to get the most accurate representation of what each loan could cost you. A good rule of thumb to know is that the closer the APR is to the advertised interest rate, the lower the lender’s fees will be.

The bottom line

Pfew! That was a lot, but there you have it! We just went over a big portion of what you’ll want to know before you enter the process of becoming a first-time homebuyer. If you have more questions or want to speak to an expert, Homespire can help with that.

 

This is not an offer for a loan or any type of extension. Eligibility for a loan or extension of credit from Homespire Mortgage Corporation is subject to completion of a loan application, credit, income, and employment qualification, and meeting established underwriting criteria. Rates are subject to change without notice based on market conditions. See Loan Consultant for information on program income limits, buyer contribution, area median income, debt requirements, and other application details.