Buying a home and beating financial obligations is a dream come true for many people. However, the journey towards homeownership is a big one, and we should take it with a lot of considerations. The truth is, getting a home and a mortgage is an uphill task, it is not anything close to jolting a signature for a lease or a rental agreement.
I know you might have come across some confusing words like prequalification, point, preapproval, and funny names such as Fannie Mae. You probably have not yet made some sense out of the terms, or you are frustrated already. Well, that is normal, and the basics will be clear to you by the time you are done reading this piece.
What Is a Mortgage
A mortgage is a loan guaranteed by a real estate. It is common for people to secure mortgages when buying properties unless you are in a position to pay cash for the home you intend to purchase. You agree with your lender to pay back the loan in monthly payments until the debt is fully paid off. Once you stop making your monthly mortgage payment, it means that you have gone into mortgage default and you have breached the terms of the loan agreement. At such a point your lender has the right to take ownership of the property and sell it to raise the remaining amount of your mortgage (foreclosure)
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What Constitutes Your Monthly Mortgage payment?
The amount you are required to pay per month for your mortgage includes:
- Principal amount- this is the total amount of loan you applied for and borrowed. It can also be called the total amount financed by your lender.
- Interest rate- this is the additional the lender will charge you for the money you borrow to buy or refinance your home.
- Taxes- this is money you pay to the authorities for the ownership of your property.
- Mortgage insurance- this is an amount of money you contribute towards a pool, to secure your home against damages.
- Private mortgage insurance (PMI)- this is an insurance amount charged to secure your home loan if the down payment you made is not 20% of the piece of your home. You are required to make the private mortgage insurance premiums until you raise the equity threshold to 20%.
- Home owner’s association (HOA) fees- this is an amount you pay to a homeowner’s association in exchange for membership subscription and renewal. The cost is only applicable when you buy your property in a community with the association.
Have You Heard of an Escrow Account?
Escrow is an account where taxes and insurance money is held and paid by the lending company when the amount is due. This is advantageous, especially when dealing with first time buyers or buyers who do not have enough savings. A portion of your monthly payment funds the account and helps you set aside reasonable monthly payments instead of the burden of annual or semi-annual costs to be funded from your pockets. However, it increases your mortgage payment and reduces your monthly income.
The escrow account is not a necessity since some lenders allow the borrower to pay the taxes and mortgage insurance directly. Ensure that you get a detailed breakdown of what is included in your monthly payment.
Prequalification Vs. Preapproval
The two terms are often used interchangeably, although they are different.
This is the process of giving your lender basic information such as your monthly incomes, your existing debts, your assets, etc. The lender uses the data to evaluate your financial position to help you get an estimate of the loan amount and terms you qualify for.
Prequalifying gives you a rough idea of the financing amount you can get, but you do not get to know if you qualify for a mortgage or not. This is because the lender does not assess your credit score or get the debt to income ratio to determine if you can qualify for a loan. The process is free.
This includes the process of filling a mortgage application form and giving the lender all the necessary documentation, proof of income, and personal records. The lender takes the time to look for and review your credit report. Usually, the process takes more time since it involves a detailed review of your credit history and finances to determine your creditworthiness. The lender charges an application fee to facilitate the preapproval process.
Once the lender ascertains that you meet all the requirements, and you qualify for a mortgage you will be able to know the lump sum amount you will get, interest rate & mortgage rate, and an estimate of your expected monthly payment.
What Is an Annual Percentage Rate (APR)?
The APR of a loan is the interest you pay per year expressed as a percentage of your loan balance. Most lenders use APR to review and quote the amount of your financing although as a homebuyer, you only think about an interest rate. An interest rate is an amount your lender charges for your borrowing. While the APR, factors the interest rate and other fees to be charged over the life of your loan. An APR is higher than the simple interest amount of your credit since it includes all your annual borrowing expenses.
PRO TIP: When comparing lending options, do not stop at the interest rate but check the quoted APRs for better decision making.
What Are Points?
A point is an equivalent of 1% of your total loan amount. For instance, if your home loan is $150,000, then one point will be 1% of $150, 000, which is $1,500. When comparing lenders and choosing a mortgage, make enquiries about closing costs, APRs, interest rates and points since they vary from one lender to another.
Lenders charge points to take care of the loan closing costs. The points can be paid by the borrower, the home seller, or the expense can be divided among the two, and it is usually collected during the loan closing.
A prepayment penalty is a fee charged when you pay off your mortgage before the expiry of the loan term. When checking out loan offers, ensure that you find out whether your mortgage has a prepayment penalty.
Standard Mortgage Forms
Whenever you apply for a home loan, you will be provided with a standard form referred to as a Uniform Residential Mortgage Application, Form Number 1003. The form is used for the recording of relevant financial information of the applicant. It contains details such as; your incomes and assets, the purpose of the mortgage, and other information necessary for loan applications.
A loan estimate shows the expected loan terms and closing costs. A lender must send you a loan estimate in three days after providing the six pieces of information, i.e.
- Your name
- Your income
- Your social security number for your credit report
- The property address
- An estimated value of the property
- The amount of loan you want
Once you have the estimate check is to ensure that the terms meet your expectations and if anything is different of not clear seek for explanations and necessary corrections.
Different Types of Loans
Financial institutions have various mortgage options that they provide to their borrowers to choose from. The loan options fall under the following categories:
- Government-backed mortgages
The government does not give money but is insures the money given to people who want to become homeowners. The three types of loans under this category include:
- FHA loans- these are backed by the federal housing administration to help people have a minimal down payment and no pristine credit, to acquire mortgages. The loan has a 3.5% down payment requirement.
- VA loans- Veteran Affairs gives flexible and low interest loans to the US military and their families. The loan does not need a PMI or down payment. The closing costs are capped and probably bore by the seller.
- USDA loans- these are loans meant to help medium to low-income earners to purchase a real estate in the US rural areas. Some options do not need a down payment for the qualifying buyers. However, you must satisfy some income limits, and the home must be in a USDA qualifying location for you to get the loan.
- Conventional loans
The government does not insure any conventional loan. The loans are ideal for people with tiptop credit score, stable incomes, and suitable employment background. The loans are classified into conforming and non-conforming loans. A conforming loan is one that meets the maximum limits set by government agencies and Fannie Mae or Freddie Mac. While a non-conforming loan is that which does not fall within the established guidelines.
- Jumbo loans
Jumbo mortgage is a type of non-conforming conventional loan. The loan exceeds federal loan guidelines, and it has stringent qualification requirements. The loan is ideal for people high incomes, a substantial down payment, and an excellent credit profile. Jumbo loans are acquired to finance high end homes.
- Fixed rate mortgages
These are loans which maintain the same interest rate throughout the loan. The mortgage payment stays the same until the loan is cleared. The mortgage comes in term options of 15, 20 or 30 years. Fixed rate mortgage is ideal for people who have no plans to leave their homes in the foreseeable future.
- Adjustable rate mortgages (ARMs)
ARMs have a fluctuating interest rate that is determined by the real estate market conditions. The loans usually have an initial fixed rate for the first few years of the loan the rate changes to be variable for the remaining life of the loan.
The mortgage is ideal for people who have plans to leave their home in a few years. You must be comfortable with a certain degree of risk-taking. But it is good to take an adjustable rate mortgage that shows how much your interest rate and mortgage rates can fluctuate, for you to make wise decisions.