Around 65% of Americans own homes, while the rest rent or live with someone. Of those that own their homes, approximately 60% (two-thirds) of them have mortgages.
Do you understand how a mortgage works? If not, you’ll need to learn about this if you want to buy a house anytime soon.
When you go to school you learn many things, but unfortunately, we’re not taught the essential facts about mortgages. Can you relate?
If so, continue reading this guide to learn seven vital facts about mortgages that you probably didn’t learn in school.
1. You Can Finance All Costs With a Mortgage
If you want to buy a house at some point, you’ll probably be asking, “How do mortgages work?”
You’ll need to learn several things before you understand mortgages, and the first is that sometimes, you can finance all of the costs of buying a house into a mortgage.
After the purchase price of the home you select, your second largest expense will be your closing costs, which can add up. Closing costs are the fees that you pay to in order close a real estate transaction. They usually average around 3-4% of your loan amount and can include fees for appraisals, attorney fees, taxes, title insurance, and more.
The good news is that some mortgage lenders will allow you to roll these expenses into your mortgage. This is more common with refinance loans than purchase loans, but ask your lender about this in case it may be an option.
If that doesn’t work, you could also ask your seller to cover your closing costs by offering them a higher purchase price of equivalent value.
For example, if your closing costs are $5K and you were going to offer the seller $200K, instead try offering the seller $205K for the property but asking them to cover the closing costs of $5K. With this approach, the seller nets the same amount from the sale so they will often agree.
Assuming that the property appraises for this higher value, this is a simple and legal way to roll the closing expenses into your home loan so you don’t have to pay them up-front.
2. You Can Choose the Duration
You might be asking, “How does a mortgage work?” One vital thing to know is that you can choose the duration of your mortgage.
For example, do you want an average mortgage duration? If so, you can choose a 30-year loan.
Some people want shorter loans though, such as 15 or 20-year loans. Others want longer loans, which you can go up to 40 years.
When choosing the duration, understand that the duration you choose affects your mortgage payments. Choosing a shorter loan adds up to higher monthly payments, but less interest paid over the life of the loan.
In contrast, a longer duration results in lower payments, but more interest paid to the bank over the life of the loan.
Consider the cost of your monthly payments and the total interest that will be due over the lifetime of the loan before selecting your duration.
3. Mortgages Come With Fixed or Variable Rates
When you view mortgages, you might notice that some offer fixed-interest rates, but others offer variable rates. Do you know the difference?
A fixed interest rate offers stability and predictability for the life of your loan. With a fixed rate, your interest rate remains the same for your entire loan. It’ll never change and neither will your payments.
In contrast, a variable rate can change. If you get a variable rate mortgage with a locked-in rate for five years, it won’t change until you reach the five-year mark. At that point, it could go up or down, but you won’t know this until it happens. This is what makes variable rates riskier than fixed interest rate loans.
4. You Need a Down Payment
When you apply for a mortgage, your lender will ask how much money you can offer as your down payment. You can find all kinds of loan programs, and each has different down payment requirements and associated loan terms.
Traditional loan programs require 20% of the purchase price as the down payment. The benefit of these loans is that you won’t be required to pay for Private Mortgage Insurance (PMI), because you’ll have a large amount of equity immediately after purchase. This protects your lender should foreclosure occur. The downside is obvious. It can take a long-time to save up a large down payment like this.
Other loan programs offer 0% or low down payment options. For example VA Loans (for military members and veterans) and USDA loans (for rural purchases) allow you to buy a primary residence with no down payment (0% down).
You can also find loans that require anywhere from 3.5% to 15%.
The down payment you will need depends on the loan program you choose and other factors. You can talk to your lender to find out which loan program is best for you based on your down payment amount.
5. Your Credit Affects Your Ability to Get a Loan
Another vital thing to know when applying for a loan is that your credit affects the lender’s decision about whether they want to lend to you and at what rate. Lenders need to assess a borrower’s risk level before issuing a loan, so they run credit checks to accomplish this goal.
If you have perfect credit (740 or higher), you’ll have more loan options to consider. With a low credit score (below 620), you’ll have fewer.
Home mortgage loans come in several different types, ranging from traditional purchase loans to construction loans, refinancing loans, and bridge loans. Talking directly to a lender is the best way to find out why type of loan you need and if your credit score will allow you to qualify.
6. Assess How the Payments Work
Before you go through the loan process, you might want to ask, “How do mortgage payments work?”
Well, your lender divides up your total loan amount by the number of payments you’ll have. For a 30-year mortgage, you will have 360 payments (30 years x 12 months = 360 payments). If your total loan amount was $360,000, this means you would owe $1,000 per month for your principal payment.
However, you’ll also have to pay interest on your mortgage payments too.
Each payment you make includes both principal and interest. The principal you pay reduces your mortgage loan balance. The interest you pay is the money the bank earns from offering you a loan. At first, you’ll pay more interest than principal, but that ratio will change as you get further into your loan.
Most lenders offer several ways to make payments. One option is to mail them to the lender. Another option is to visit a branch of the bank to make your payment in person. More commonly, you will pay your monthly payments online and most lenders allow you to set up automatic payments.
7. You Might Have to Pay Mortgage Insurance
One last thing to know is that some people must pay private mortgage insurance (PMI) on their loan. PMI is an insurance product that protects lenders in the event that you stop making your mortgage payments.
If you borrow more than 80% of your home’s purchase price, you might have to pay this extra expense. You won’t have to pay it for the entire duration of your loan, but you might have to for a while.
Learn These Facts About Mortgages
By learning these important facts about mortgages, you can understand more about the home buying process. As a result, you might know how to find the best mortgage for your situation.