About Mortgages
As you embark on your home purchase, shopping for the right mortgage that works best for you is just as important as choosing the right house. A major part of your decision is considering the type of interest rate (fixed or adjustable) and whether a conventional loan or a government-guaranteed or insured loan is best for you.
There are many different types of mortgages to choose from, and an important aspect of the process is to choose the mortgage that works for you now and in the future. Part of the challenge is to select the loan terms that are most favorable to your situation. In selecting the loan that’s right for you, you’ll need to understand:
Basic components of a mortgage loan
Fixed-rate mortgage
Adjustable-rate mortgage
Government loans and programs
Balloon loans
Other affordable housing loans
Basic Components of a Mortgage Loan
A mortgage requires you to pledge your home as the lender’s security for repayment of your loan. The lender agrees to hold the title or deed to your property (or in some states, to hold a lien on your title or deed) until you have paid back your loan plus interest.
The following are the basic components of a mortgage loan:
Mortgage Amount and Term
The mortgage amount is the amount of money you borrow from a lender to pay for your house.
The term is the number of years over which you can pay back the amount you borrow.
Note:
The length of your mortgage repayment period will directly affect your monthly mortgage payments. The most popular mortgage term is 30 years. By extending payment over 30 years, you keep your monthly housing costs low. If you can afford higher monthly payments, you can select a mortgage term that is shorter. There are 20-year, 15-year, and even 10-year fixed-rate mortgages available from most mortgage lenders. The longer your repayment period is, the lower your monthly payments will be, but the total interest you pay over the life of the loan will be more.
Amortization
Over time, you will repay your mortgage through regular monthly payments of principal and interest. During the first few years, most of your payments will be applied toward the interest you owe. During the final years of your loan, your payment amounts will be applied primarily to the remaining principal. This type of repayment method is called amortization.
Fixed or Adjustable Interest Rates
Interest rates are usually expressed as an annual percentage of the amount borrowed. You can choose a mortgage with an interest rate that is fixed for the entire term of the loan or one that changes throughout. A fixed-rate loan gives you the security of knowing that your interest rate will never change during the term of the loan. An adjustable-rate mortgage (called an ARM) has an interest rate that will vary during the life of the loan, with the possibility of both increases and decreases to the interest rate and consequently to your mortgage payments.
Down Payment
The down payment is the part of the purchase price the buyer pays in cash and is not financed with a mortgage. Your down payment will reduce the amount you’ll need to borrow. So, the more cash you put down, the smaller the size of your loan, and the smaller the amount of your mortgage payments.
Tip:
Lenders often view mortgages with larger down payments as more secure because more of your own money is invested in the property. However, there are other loans that require as little as 3% to 5% of the purchase price for a down payment.
Closing Costs
The closing (or, in some parts of the country, settlement) is the final step, during which ownership of the home is transferred to you. The purpose of the closing is to make sure the property is ready and able to be transferred from the seller. The closing costs (which vary from state to state) are usually expressed as a percentage of the sales price or loan amount. Typically, costs range from 3% to 6% of the price of your home and can include transfer and recordation taxes, title insurance, the site survey fee, attorney fees, loan discount points, and document preparation fees.
Tip:
Sometimes you can negotiate to have the seller pay some of your closing costs.
Discount Points
In mortgage lending vocabulary, “points” in layman's terms, are a type of fee that lenders charge. (The full term to describe this fee is “discount points.”) Simply put, a point is a unit of measure that means 1% of the loan amount. So, if you take out a $100,000 loan, one point equals $1,000. Discount points represent additional money you can pay at closing to the lender to get a lower interest rate on your loan. Usually, for each point on a 30-year loan, your interest rate is reduced by about 1/8th (or .125) of a percentage point.
Tip:
Usually, the longer you plan to stay in your home, the more sense it makes to pay discount points.
Conforming and Nonconforming Loans
The term “conforming,” as opposed to “nonconforming,” is sometimes used to explain loans that offer terms and conditions that follow the guidelines set forth by Fannie Mae and Freddie Mac. These are the two private, congressionally chartered companies that buy mortgage loans from lenders, thereby ensuring that mortgage funds are available at all times in all locations around the country.
The most important difference between a loan that conforms to Fannie Mae/Freddie Mac guidelines and one that doesn’t is its loan limit. Fannie Mae and Freddie Mac will purchase loans only up to a certain loan limit (currently $227,150, but will be $240,000 as of January 1, 1999). If your loan amount will be for more than the conforming loan limit, the interest rate on your mortgage may be higher or you may have slightly different underwriting requirements, particularly in regard to your required down payment amount. Check with your lender about this if you are taking out a large loan amount.
Tip:
Nonconforming loans are sometimes called jumbo loans.
