Buying a home can be a path to building savings and putting down roots in a community. But with median home prices higher than $400,000 in the United States today, many people can’t take this step without borrowing money. That’s where a mortgage comes in.
What Is a Mortgage?
A mortgage is an agreement you make with a lender when you borrow money to buy a home. A mortgage gives the lender the right to take your home through foreclosure if you don’t repay the loan as promised. Typically, a mortgage puts a lien on your property title, meaning that you own the home but the lender has a legal claim on the property until the loan is paid off.
How Do Mortgages Work?
When you take out a mortgage loan, a lender provides upfront funds for you to use on a home purchase. You then repay the amount you borrowed plus interest over the mortgage’s term, which is often 15 or 30 years.
If you choose a longer loan term, you will typically have smaller monthly payments. But the interest rate will likely be higher, and you’ll often end up paying more interest in total.
Lenders may allow you to choose between higher upfront costs or higher monthly payments by offering discount points. Discount points are essentially fees you can pay when you take out the loan to get a lower interest rate. For each point that you buy, the lender lowers the interest rate on the loan by a set amount.
After you take out a mortgage, you make monthly payments to a mortgage servicer. This is the company that manages the loan, which may be separate from your lender. Your monthly payment covers several things, including the loan principal, interest, property taxes and insurance.
[Read: Best Mortgage Lenders]
Mortgage Process Steps
The mortgage process begins with talking to a lender about your finances and determining how much home you can afford. After you’ve chosen a home and made an offer, you put in a formal mortgage application. If the lender approves your application, you will then go through a closing process to complete all the necessary paperwork related to your home purchase.
Here’s what happens at each step.
1. Preapproval. Before they’ll negotiate with you, sellers and listing agents want to see that you can get financing to back your offer. So as a first step, you need to apply for preapproval. The process can vary a bit between lenders, but it usually involves sharing information about your income, assets and debts. The lender then gives you a letter stating that it would likely give you a loan up to a specified amount.
2. Shopping for a home. Next, you look at homes. “That’s the fun part,” says Mason Whitehead, branch manager and senior loan officer at Churchill Mortgage in Dallas. “That’s when you’re actually in a car. You’re driving out there — you’re looking at houses.” When you decide on the home you want, you work with a realtor to submit an offer. The seller can accept or reject your offer, or ask for changes. Once you reach an agreement with the seller, both of you sign the purchase agreement.
3. Applying for the mortgage. Now that you’ve chosen the home you want to buy, you can request loan estimates from multiple lenders. After you choose the loan you want, tell the lender you’re ready to move forward with a formal application. At this point you’ll need to provide all the required financial documentation and answer any questions the lender has.
4. Underwriting. Your submitted application goes to the lender’s underwriting department, where it’s reviewed carefully. “Every scrap of paperwork that (you) give the lender is going to get looked at and it’s going to be analyzed,” says Craig Garcia, president of Capital Partners Mortgage Services in Coral Springs, Florida. “There’s a lot of tedious scrutiny that happens over literally every page of the documentation that (you) provide.” The underwriter will probably ask you to share additional documents and to explain any discrepancies. Once the lender is satisfied that you meet all the requirements for the loan, you will be cleared to close.
5. Home inspection and closing services. You’ll need to have a home inspection performed to assess the home’s condition, and your lender will order an appraisal to confirm the home’s value. You may also need to buy title insurance and arrange for other closing services, which will be listed in your loan estimate.
6. Closing. To close on the mortgage, you typically go to a title company office, where you meet with your real estate agent, the seller’s agent and a closing agent. You’ll typically wire money or bring a cashier’s check to make your down payment and pay closing costs. Then, you’ll sign the mortgage, the promissory note and other documents.
After all the hard work you put into applying for the mortgage, closing can feel like a celebration. “We have a party, we pop the champagne bottles, and everybody’s happy,” Whitehead says.
[Read: Best Adjustable-Rate Mortgage Lenders.]
What Types of Mortgages Are There?
Lenders offer a variety of mortgage types to accommodate borrowers in different circumstances. “There are so many different loan programs now,” Garcia says. “It doesn’t mean that everybody has a loan program that will fit for them today, but probably a lot of people have something that they can work towards if they don’t fit into one of those boxes.”
Learn about the main mortgage types:
Fixed-Rate Mortgages
Fixed-rate mortgage loans have interest rates that stay the same for the entire life of the loan. The monthly payments are typically the same size throughout the loan term, so it’s easy to budget for them.
Adjustable-Rate Mortgages
Adjustable-rate mortgages start out with a fixed rate for a set period of time, which could be up to a few years. After that, the interest rate could go up or down at regular intervals based on its underlying index, a measure that reflects interest rates throughout the economy. There may be caps that prevent the interest rate from rising or falling beyond certain levels. When your interest rate changes, your payment changes too.
The initial rate on an adjustable-rate mortgage is often lower than on a fixed-rate home loan. The downside is that the rate could go up, so how much you’ll end up paying each month and how much interest you’ll pay in total can be hard to predict.
Conventional Mortgages
Conventional mortgages are home loans that aren’t issued as part of certain government programs. They fall into two categories: conforming and non-conforming.
Most mortgages are conforming loans, which means that they meet the requirements to be sold to Fannie Mae or Freddie Mac, the government-sponsored enterprises that buy mortgages from lenders. These loans can’t be larger than the conforming loan limit, which is updated each year. In 2023, the limit for most parts of the country is $726,200.
Non-conforming loans don’t need to meet Fannie Mae’s and Freddie Mac’s requirements. When they’re larger than the conforming loan limit, they’re called jumbo loans. These loans are different from one lender to the next and can be more difficult to qualify for.
“You might talk to one lender and they want 20% down. You might talk to another lender and they want 10% down, 15% down, and the terms could vary widely. It’s just based on every different lender’s particular lending appetite and risk appetite at the time,” Garcia says.
If you make a down payment below 20% of the purchase price on a conventional loan, you usually have to pay private mortgage insurance. This insurance policy reimburses your lender if you don’t pay back your loan, but it doesn’t shield you from any of the consequences of failing to make payments like foreclosure and damage to your credit.
Government-Backed Mortgages
Government-backed mortgages are usually offered by private lenders and insured by a federal agency. Some of these loan types are directly issued by government agencies.
If you have a low credit score or low income, it might be easier to qualify for a government-backed loan than a conventional loan. But you’ll still need to meet the eligibility requirements for the mortgage program.
Here are the main categories of government-backed mortgages:
— Federal Housing Administration loans. Borrowers who have low credit scores or who have experienced a foreclosure or bankruptcy in the last few years might have an easier time getting an FHA loan than a conventional loan. But you have to pay a mortgage insurance premium, and this could be more expensive than private mortgage insurance in some cases. With FHA loans your down payment can be as little as 3.5%.
— U.S. Department of Agriculture loans. You may be eligible for a USDA loan if you’re buying a home in a rural area or sparsely populated suburb and you have low to moderate income. These loans may not require a down payment, but you’ll still need to pay for mortgage insurance.
— Department of Veterans Affairs loans. These mortgages are open to eligible veterans, service members and surviving spouses. VA loans generally offer favorable interest rates and low closing costs, and they typically don’t require a down payment. You’re usually charged a funding fee unless you became disabled while serving or qualify for a different exception.
What Are Average Mortgage Rates?
Average mortgage rates have climbed significantly over the last few years and are now at 20-year highs. Still, today’s rates remain below the averages seen a few decades ago.
How to Choose a Mortgage
To select the right mortgage for you, start with your budget. You must be able to comfortably afford the mortgage payments plus other costs of owning a home, such as homeowner association fees and maintenance expenses.
“You can qualify for a payment up to $3,000 a month, but should you? Those are two very different conversations,” Whitehead says.
Think about how long you plan to stay in the home. If you expect to hold onto the mortgage for many years, it might make sense to pay points upfront and get a lower interest rate. And you may be better off with a fixed-rate mortgage because you don’t have to worry about your payments going up later.
If you’re going to move again soon, you likely don’t want to increase your upfront costs. And you might be willing to accept the risk of an adjustable-rate mortgage if you’re confident you’re going to sell before the rate changes.
Compare the annual percentage rate on different mortgage loans to see how their costs stack up. An APR takes into account the interest rate on the loan plus fees and points, so it gives you a better sense of how expensive a mortgage is beyond just the interest rate.
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What Is a Mortgage? originally appeared on usnews.com
