Houses are expensive, and most people do not have $200,000 in cash, which is about the median value of homes in the United States. There are many banks that will finance a house, and government backed programs that allow for low down payments to encourage home ownership. When you borrow money for a house, you are most likely using a mortgage. A mortgage is a loan that can be paid off over varying amounts of time. The most common mortgage has a 30 year term, meaning if a homeowner paid the minimum payments, they would pay off the loan in 30 years. There are 25, 20, 15, 10 and even 5 year terms for mortgages. The longer the term of the loan, the lower the payment will be for the borrower. For every payment made, some money goes to the principal balance, and some to interest. In the beginning of the loan, much more money goes to interest than principal, but as the loan matures more money will go to principal. The bank will base the loan amount on the value of the home, which is determined by an appraisal.
How does a mortgage work?
There are many things to consider when getting a mortgage:
- What is the down payment? Lenders will require the buyer pay a down payment when getting a loan. The down payment can vary from 3 percent (VA offers $0 down), 5 percent, 10 percent, or as much as the borrower wants to pay. When you have a lower down payment you will most likely pay mortgage insurance which can add hundreds of dollars to your payment.
- What are the closing costs? Besides the down payment, the borrower will have closing costs as well. The closing costs consist of lenders fees, appraisals, pre-paid insurance, pre-paid interest, title insurance fees, and title company fees. The closing costs can be from 2 to 6 percent of the loan. In some cases the borrower can ask the seller of a home to help pay the closing costs.
- What is the payment? The monthly payment is determined by an algorithm that takes into account the interest rate, the length of the loan, and any mortgage insurance. If you get a 15 year loan, the payment will much higher than a 30 year loan. The lower the interest rate the lower your payment will be as well. Here is an article with more information on how much payments would be on a $200,000 house.
- How much house can you qualify for? The lender will tell you how much you can qualify for. This does not mean you should try to max out that number! The lender is not concerned with how much money you can save, only if you can make the payments. It may not be smart to buy the most expensive house you can get a loan on.
How is the payment figured on a mortgage?
Every month part of your payment is used to pay interest and part of your payment is used to pay principal (the amount of your loan). It is not easy to figure your payment, because the amount varies based on how long the loan term is and your interest rate. On a $200,000 house your payment would be $1,755 a month at 10 percent interest on a 30 year loan. If the interest rate was 5 percent, the payment would be $1,074 a month. If the interest rate was 5 percent on a 15 year loan, the payment would be $1,582 a month. The payment is much higher on a short term loan, because you have less time to pay off the balance.
On the $200,000 loan, with a 5 percent interest rate, $249 of your payment would go towards paying off your loan and $833 would go towards paying interest in the first month. The cool part about mortgages in the US, is the interest is tax deductible in most cases. The longer you have the loan, the more of your payment will go toward paying the loan, and less will go toward interest. In three years, $279 will go towards your principal and $794 will go towards interest.
Every month the amount of principal and interest being paid will change. You will pay much more interest in the beginning of mortgage, than at the end. Here is a great site for calculating the mortgage payment. Besides the interest and principal, most mortgage include taxes and insurance. Every property will have property taxes you have to pay to the government and the lender will require you have home owners insurance. Those costs are included in the payment, because the lender wants to protect their investment. Tax rates can vary greatly by the state you are in. In some states taxes and insurance might add $200 a month to your payment and in other states, $800 might be added to your payment.
When do you have to make your payment on a mortgage?
When you first get a mortgage the first payment is not usually due the next month. If you buy a house on December 15th, your first payment most likely will not be due until February 1st. It is nice that borrowers get to skip a payment, but they still have to pay that interest up front for the skipped loan (prepaid interest). Even though the payment is due on the first of the month, it is not considered late until the 15th of the month. You can safely make your payment on the 15th, pay no late fees and not hurt your credit with most loans. If you make the payment after the 15th of the month it is considered late. The lender will assess late fees, which will be detailed in your loan documents. The lender may report the late payments to the credit bureaus hurting your credit rating as well. If you start to miss payments, you risk the loan going into default. The laws are different in each state, but a lender can foreclose on a loan after a certain amount of missed payments.
The bank cannot take the home away from borrowers after a couple of missed payments, they must foreclose on it. That means they have to go to the courts, trustee, or sheriff (depending on the state you live in), show proof the borrower missed payments, and start the foreclosure process. The homeowner must be notified of the foreclosure and given a chance to catch up on payments to bring the loan current. In some states it can take a few months to foreclose, and in other states it can take years.
What are the different types of mortgages?
Not every mortgage is the same. There are private mortgages and government backed mortgages. The government backed mortgages were created to help more people buy homes with less money down. In the past banks would require at least 20 percent down to buy a house. Now there are many programs that allow people to buy homes for less than 5 percent down.
- Conventional: This loan is from a bank, with no government backed down payment assistance programs.
- FHA: This loan is insured by the federal government. A regular bank will lend the money to the borrowers, but a certain amount of the loan is guaranteed by the government allowing a lower down payment.
- VA: This loan is for veterans of the military and active duty. The loan is guaranteed by the government and is available with zero money down.
- USDA: These loans are available in rural areas and allow low down payments backed by the government.
- Local and state programs: there are many state and even city programs that give grants to homeowners.
What determines the down payment when you get a mortgage?
Typically the lower the down-payment the more expensive the loan will be. Banks are comfortable loaning 80 percent of the value of a home, since the borrower would need to bring the other 20 percent as a down payment. The bank feels safe knowing the borrower has skin in the game (they are spending some of their own money), and if something goes wrong the bank has built in equity. Luckily for many borrowers who do not have 20 percent down, there are private mortgage insurance companies and government programs that will allow a lower down payment. FHA has as little as 3.5 percent down payment and some conventional loans as little as 3 percent down payment. With the lower down payment comes more costs. Both loans will have mortgage insurance which can be hundreds of dollars a month. VA has no mortgage insurance and no down payment, but can only be used by those in the military or veterans.
The best strategy depends on the borrower’s financial position. If a borrower can get a conventional loan with private mortgage insurance, it is usually better than FHA. The costs on FHA loans are higher and the mortgage insurance cannot be removed on FHA, but may be removed on conventional. The home value must exceed 80 or 75 percent of the loan for the insurance to be removed. The advantages of FHA are the borrower can qualify for more and have a lower credit score.
If a borrower can put 20 percent down, that may be the best strategy to avoid the mortgage insurance.
How can you qualify for a mortgage?
The banks look at debt to income ratios when determining who can qualify for a loan and for how much. Someone who makes $100,000 a year may qualify for less than someone who makes $50,000 a year if the person making $100,000 a year has a lot of debt. The bank will look at monthly debt payments versus monthly income. High car payments, credit card payments, child support can increase debt to income ratios making it harder to qualify for a home. For those with low income and little cash, FHA coupled with a local down payment assistant program can be a great option to get into a house. FHA allows higher debt to income ratios, than conventional loans.
There are many other factors to consider when qualifying for a loan.
- You must have worked at the same job or in the same field for two years.
- You must have decent credit (usually at least 620).
- You cannot have had a short sale or bankruptcy recently.
What is the process for securing a home loan?
The first step to getting a mortgage is to talk to a lender or banker. If you are looking to buy a house, many real estate agents can recommend a good lender. There are good lenders and bad lenders, and a bad lender can cost the borrower a lot of money. Here is a great article on how to find a real estate agent.
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