Mortgage Basics For Beginners
For many, owning a home is part of the American dream. For most homeowners in America, getting a mortgage is just one of the steps it takes to get there.
If you’re contemplating homeownership and wondering how to get started, you’ve come to the right place. Here, we’ll cover all the mortgage basics, including loan types, mortgage lingo, the home buying process, and more.
First Things First: What’s A Mortgage?
First, what does the word “mortgage” even mean? A mortgage is simply a loan you use to buy a house. Mortgages are how most Americans buy homes, and they’ve been around since the 1930s.
When you get a mortgage, you agree to pay the lender interest in exchange for lending you the money. The amount the lender can give you varies depending on your income, how much money you have saved, and your credit history, which is a record of how well you’ve repaid your debts in the past.
Who Gets A Mortgage?
Most people who buy a home do so with a mortgage. A mortgage is a necessity if you can’t pay the full cost of a home out of pocket.
There are even some cases where it makes sense to have a mortgage on your home even though you have the money to pay it off. For example, investors sometimes mortgage properties to free up funds for other investments.
Different Types Of Mortgages
Not all mortgages are the same. There are different types of rates, different loan terms, and different loan products. Let’s take a look.
When you’re choosing your loan, you’ll need to figure out whether you want a fixed rate or an adjustable rate.
Most buyers opt for a fixed rate, which is simply an interest rate that doesn’t change over the life of the loan. If your interest rate is 4.5% when you close, then you’ll keep that 4.5% interest rate for the life of your loan. This means the principal and interest portion of your monthly payment won’t change. The fixed interest rate ensures your payment remains relatively stable until the loan is paid off.
Adjustable rates, on the other hand, are rates that change over the life of the loan. In most cases, your adjustable-rate mortgage (ARM) will have an initial fixed-rate period in which the rate won’t change. But once that fixed-rate period is up, your interest rate will adjust up or down, usually once per year, depending on the market. This means your payment will change as your interest rate changes.
ARMs might seem like a risky option, but they actually make a lot of sense for homeowners in certain situations. Interest rates for ARMs are generally lower, so if you know you won’t stay in the home for longer than the fixed-rate period, ARMs can be a great way to save on interest.
The phrase “loan term” refers to the period of time over which you’ll pay back the loan. In most cases, you’ll be able to choose the loan term.
The most popular loan term is 30 years. A longer loan term means a lower payment, since the payments are spread out over time, so a 30-year mortgage will usually give you the most affordable mortgage payment.
Another popular choice is a 15-year term. While your payment might be higher with a 15-year term, you’ll usually be able to save a lot of money on interest. Interest rates for 15-year loans are usually lower, and since you’re not making as many payments, you save on interest that way too.
Quicken Loans® offers terms between 8 and 30 years. While the selection may be more limited depending on the lender and the loan product you choose, the important thing to know is that choosing the right term is a great way to fit the loan to your budget.
There are many different types of loan products, and each has different benefits and requirements.
Conventional loans are a popular choice. A conventional loan is one that’s not backed by the government. Conventional loans can have a fixed or adjustable rate. In some cases, you can even qualify for a conventional loan with as little as 3% down. However, conventional loans have stricter credit requirements than some other loan types.
Many other loan types are backed by the government. The government backing usually means easier qualifications.
A popular government-backed loan is an FHA loan. This is a loan that’s backed by the Federal Housing Administration. Many people choose FHA loans because they have lower credit requirements and offer the ability to get a loan with as little as 3.5% down.
The downside of an FHA loan is that you’ll have to pay mortgage insurance. There’s an upfront mortgage insurance premium you’ll have to pay when you get the loan, as well as mortgage insurance costs that you’ll have to pay for either 11 years or the life of your loan, depending on the size of your down payment.
There are other loan products that are backed by the government that are specific to certain types of buyers. VA loans, for example, are only available to active-duty service members, veterans, and the surviving spouses of veterans. VA loans don’t require a down payment or mortgage insurance.
USDA loans are another example of a government-backed loan. USDA loans can only be used to purchase homes in qualifying rural areas, however, and are subject to income limits.
Other Important Mortgage Terms To Know
The right mortgage company will explain everything you need to know, but knowing some basic mortgage lingo will help you feel more comfortable with your decisions.
The fee you pay to borrow money is known as mortgage interest. You pay for mortgage interest as part of your monthly payment. The annual percentage rate (APR) shows you the full picture of what you’ll pay annually in interest and other fees. It’s presented as a percentage of your total loan balance.
Lenders base the interest rate they charge on the market at the time you get your loan and the amount of financial risk you present. They look at your financial history to decide whether you’re likely to default on the loan. The size of the down payment, the property location and the loan type are just some of the other factors that impact the interest rate you pay. The riskier you are, the higher your interest rate will be.
The down payment is the money you pay upfront to purchase a home. In most cases, you have to put money down to get a mortgage.
The size of the down payment you’ll need will vary based on the type of you’re getting, but a larger down payment generally means better loan terms and a cheaper monthly payment. For example, conventional loans require as little as 3% down, but you’ll have to pay a monthly fee (known as private mortgage insurance) to compensate for the small down payment. On the other hand, if you put 20% down, you’d likely get a better interest rate, and you wouldn’t have to pay for private mortgage insurance.
A mortgage calculator can help you see how your down payment amount affects your monthly payments.
Private Mortgage Insurance (PMI)
Private mortgage insurance (PMI) is a fee you pay to protect your lender in case you default on your conventional loan. In most cases, you’ll need to pay PMI if you don’t put 20% down. The cost of PMI can be added to your monthly mortgage payment, covered via a one-time upfront payment at closing or a combination of both. There’s also lender-paid PMI, in which you pay a slightly higher interest rate on the mortgage instead of paying the monthly fee.
The mortgage servicer is the company that’s in charge of providing monthly mortgage statements, processing payments, managing your escrow account and responding to your inquiries.
Your servicer is sometimes the same company that you got the mortgage from, but not always. Often, lenders will sell the servicing rights to your loan. If you don’t get to choose your servicer, you can’t guarantee that you’ll end up with great customer service. However, at Quicken Loans®, we service 99% of our loans so we can be there to help you throughout the life of your loan.
Part of each monthly mortgage payment will go toward paying interest to your lender, while another part goes toward paying down your loan balance (also known as your loan’s principal). Amortization refers to how those payments are broken up over the life of the loan. During the earlier years, a higher portion of your payment goes toward interest. As time goes on, more of your payment goes toward paying down the balance of your loan.
Part of owning a home is paying for property taxes and homeowners insurance. In many cases, you can opt to pay for these expenses as part of your monthly mortgage payment.
To make it easy for you, lenders set up an escrow account to pay these expenses. Your escrow account is managed by your lender and functions kind of like a checking account. No one earns interest on the money held there, but the account is used to collect money so your lender can send payments for your taxes and insurance on your behalf.
Not all mortgages come with an escrow account. If your loan doesn’t have one, you have to pay your property taxes and homeowners insurance bills yourself. However, most lenders offer this option because it allows them to make sure the property tax and insurance bills get paid.
Home loans can seem complicated, but knowing the basics about credit requirements, loan terms and types, down payments, escrow and insurance can set you up for success. When you're ready to start the buying process, apply online with Rocket Mortgage® by Quicken Loans®.
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