A mortgage is a loan that gives you the opportunity to buy a home without having to pay upfront. Instead, a mortgage allows you to put down a smaller amount of money. Typically, this is around 20% of the property’s value and you finance the rest with borrowed money.
A mortgage is a secured loan, meaning it’s backed by the real estate property as collateral. If you don’t repay the money you’ve borrowed along with interest, the lender has a right to seize your property to recover their losses.
Aside from wondering what is a mortgage, there are plenty of questions surrounding this topic. If you’re asking yourself “how much mortgage can I afford?” or “how much mortgage can I qualify for?” – you’ve come to the right place.
We’ll go over everything you need to know about how mortgages work.
How Does a Mortgage Work?
Asking how does a mortgage work is a heavy question. Particularly, this is because there are so many different components to a mortgage and the entire system. It’s a good idea to start with these basics.
Basic Mortgage Terminology
Amortization: When a loan is being paid off with a series of fixed-payments over a set amount of time. Most mortgages are structured this way.
Escrow: A legal agreement where a third-party temporarily holds a large sum of money or another asset of value. However, in the context of mortgages, escrow pertains to the buyer’s cash deposit for the property as well as funds for taxes.
Down Payment: An up-front, partial payment you make in order to secure the property and the mortgage. Most lenders require a down payment of at least 20% of the property’s selling price, but it’s not uncommon for borrowers to pay less. Also, you’re free to make a larger down payment if you wish.
Interest Rates (fixed vs. adjustable): Interest is the cost of borrowing money, it’s calculated as a percentage of the total amount of your loan. A fixed-rate mortgage means your interest rate will remain the same for the entire duration of the loan. An adjustable rate mortgage means your interest rate will fluctuate, and you may end up paying more depending on market conditions.
Who Is Involved?
Buying a home is a process that involves a number of different players, oftentimes including: the buyer, the seller, the real estate agent, the attorney, the home inspector, the appraiser, the title company, and the home insurance company.
Mortgage Terms
If your mortgage is at a fixed-rate, you’ll be able to choose a loan term of either 10, 15, 20, or 30 years. The shorter the time frame, the less money you’ll shell out in interest over the duration of the loan – but you’ll also have to contend with higher monthly payments.
What Is Your Mortgage Payment Comprised Of?
Principal: The total amount of money you’ve borrowed.
Interest: The cost of your principal, or the amount you’ve borrowed. Interest is calculated as a percentage of your principal.
Taxes and insurance: Your property taxes are bundled together with your monthly mortgage payment. Your homeowners insurance can be incorporated too.
How To Get a Mortgage
Getting a mortgage is a process with many separate steps. It may seem overwhelming at first, but it’s actually straightforward once broken down. Take a look!
Pre-Approval
Pre-approval means the lender has vetted your finances and determined your eligible for a specific loan amount. It’s a good idea to get pre-approved before you start browsing properties. You’ll want to have an idea of what you can afford beforehand, plus sellers will be more likely to take you seriously with a pre-approval ready.
Shop for Your Home
Once you’ve been pre-approved for a specific loan amount, you can begin shopping for your home! At this phase, you’ll want to get in touch with a realtor, check local listings, and attend open houses.
Once you find a property within your price range that you feel confident about, you can make an offer. Your realtor will relate your offer to the seller and the seller’s agent. If they accept, you’re on your way to homeownership.
Final Approval
The final approval process is when your mortgage lender takes an in-depth look into your finances to determine the rates and terms you qualify for. In short, this is also known as the underwriting process.
The lender will also want to ensure the value of your home is legitimate, so they will send out an appraiser.
Closing
Once you’ve been approved for your mortgage terms, you’ll officially become the property owner on closing day. You’ll need to have your cash ready for the down payment as well as other closing costs. Lastly, once everything has been verified, you’ll sign the documents and receive the keys!
How Much Mortgage Can I Afford?
Asking yourself “how much mortgage can I afford?” The answer to this question will depend on a number of factors. Ultimately, you’ll want to settle for a down payment amount and monthly mortgage payment amount that you are comfortable with.
How Much Mortgage Can I Qualify for?
Lenders will look into a few different factors to determine how much mortgage you qualify for. For starters, the amount of money you’re willing and able to make for a down payment will have a big influence.
Perhaps the most important factor is your monthly income. Lenders will verify how much money you have coming in, your total existing assets, your debt obligations, as well as your monthly expenses. This can include taxes, association dues, insurance, car payments, credit card payments, and more.
Your credit history will also have influence over how much mortgage you qualify for and the interest rate you get.
How to Calculate Mortgage Payment
Follow the steps below to calculate your monthly mortgage payment.
Step 1: Determine your mortgage principal, or the amount of money you’re going to need to borrow.
Step 2: Calculate your monthly interest rate by dividing the annual interest rate (the interest rate your lender provides) by 12. Say your annual interest rate is 3%, your monthly interest rate would be .03/12 = .0025 or .25%.
Step 3: Figure out how many total monthly payments you will have by multiplying the number of years of your mortgage by 12. Say you have a fixed-rate 30-year mortgage. Your total payments would be 30 times 12 = 360.
Step 4: Find out how much your homeowners insurance will cost you each month by asking different providers the best rate they can offer you.
Step 5: Head to your local municipality’s government website or call the town hall to find out what you can expect to pay in property taxes.
Step 6: Lastly, once you have all your figures laid out, follow the following formula to find your monthly mortgage payment.
Monthly Mortgage Payment =
Principal [monthly interest rate (1 + monthly interest rate)^total monthly payments ] / [ (1 + monthly interest rate)^total monthly payments – 1]
Types of Mortgages
Before you meet with a lender to discuss the mortgage terms you qualify for, you’ll want to have an idea of the different types of loans out there. More importantly, here are the most common types of mortgages.
Conventional
A conventional mortgage is any type of homeowner’s loan that is not secured by the government. Instead, a conventional mortgage is a loan that’s offered by a private lender, such as a bank.
FHA
A Federal Housing Administration (FHA) mortgage is issued by the FHA and intended for low-to-moderate-income borrowers or first-time buyers. Typically, FHA loans require lower down payments and lower credit scores than conventional mortgages.
USDA
United States Department of Agriculture (USDA) mortgages are government backed homeowner’s loans that require zero down payment, low credit scores, and oftentimes are accompanied by low-interest rates.
However, USDA mortgages are intended for low-income Americans with poor credit and can only be used to purchase homes in designated, suburban or rural areas.
VA
Veterans Affair (VA) home loans are federally backed mortgages designated for active and veteran service members and their families. More importantly, VA mortgages don’t require a downpayment and come with low-interest rates.
Consult With a Financial Advisor to See Which Mortgage Is Right for You
Hopefully, by now you know what a mortgage is and how to get one. The next step is actually sitting down with different lenders to find out what they can offer you based on your unique financial situation.
If you need help navigating your options and determining which type of mortgage is right for you, a financial advisor can help. Financial advisors are investment and money management professionals that help people make the best decisions.
In conclusion, from investing, budgeting, planning, and mortgages – financial advisors are a valuable resource for helping you get the most out of your finances.