How Mortgages Work

Chances are, buying a home will be the biggest investment you’ll make in your lifetime. It’s a major life-changing commitment that requires knowledge and planning. Thus, it’s vital that, when it comes to getting a home loan, you know how mortgages work. Here’s that and more.

Explain What a Mortgage Is

It’s a loan from a bank or other financial institution that helps a person buy a home. The term for such a loan is usually 15, 20, or 30 years. During this period, the borrower repays the loan amount plus interest.

Note that the house serves as mortgage collateral. Thus, the borrower must be certain that they can repay the loan since the lending institution can otherwise sell the house to recoup its money.

The Benefits of Home Ownership

Beyond a sense of security and pride in ownership, there are definite benefits to home ownership. The chief one may be that your house will likely, over time, appreciate, despite cyclical housing markets. In fact, those who bought a house a decade ago have gained an average of $225,000 in equity.

There are also tax advantages such as property tax deductions and a capital gains exclusion.

Home ownership also benefits communities, in that owners are “invested.” They are more apt to maintain their homes and yards, for example, heightening property values and neighborhood impressions. This, in turn, results in more community investment.

There are also familial benefits, in that parents who feel stable spend more time with their children. This stability tends to affect children’s behavior and future educational and economic success.

How Mortgages Work

Each mortgage payment you make is comprised of these elements:

• Principal. This is the part of your balance that decreases with each payment.
• Interest. The lender charges the interest rate for the mortgage you select.
• Taxes. Based on the amount assessed annually in your neighborhood, you’ll fork over 1/12^th of your annual property bill monthly.
• Insurance. Homeowners are required by lenders to carry insurance against theft, fires, or accidents. Based on your loan type or down payment, there may be another, separate monthly payment for mortgage insurance.

Qualifying for a Mortgage

Factors lenders consider when one applies for a mortgage include:

Your Credit Score

The higher your credit score, the lower your mortgage payment and interest rate will be. The same applies for a home equity loan with Achieve. For a mortgage, you’ll likely need a minimum FICO score of:

• 620 for an adjustable-rate or fixed-rate conventional mortgage
• 580 for a government-backed minimum down payment
• 500 for a government-backed loan with a down payment of at least 10 percent

Your Debt-to-Income Ratio

Lenders want to see your DTI — your total monthly bill payments divided by your gross monthly earning – to gauge how you handle your monthly payments and repay what you’ve borrowed. While some lenders will accept DTIs above 50 percent, no more than 43 percent is recommended.

Your Income

You’ll need proof of a stable and consistent income (tax returns, W-2s, etc.). Lenders will also factor in how long you’ve been on the job and in your field of work.

Your Down Payment

While you may not need a down payment, in general, the bigger your down payment, the less your monthly payment will likely be. You’ll likely need two months of bank statements to demonstrate from where your funds will be derived.

Monetary Reserves

Lenders want to be sure that, if you experience a financial bump, you have assets that you can convert to money to make your mortgage payments. These “mortgage reserves” can give you an edge, particularly if your credit scores are low or you have an elevated DTI ratio.

Such reserves can be the cash value of life insurance policies, vested retirement account assets, investments, or cash in savings and checking accounts.

Types of Mortgages

The different types of mortgages include:

• Fixed-rate loan. The monthly payment stays the same.
• Adjustable-rate mortgage. You’ll get a lower rate for a set period, followed by a rate increase, or decrease, depending on the ARM type.
• Long-term loans. The longest term offered is usually 30 years, which carries the lowest possible payment. However, you’ll shell out more for interest over the loan’s life, and your interest rate is usually higher.
• Short-term loans. The shortest available term is usually a 10-year fixed-rate mortgage. Your payment will be higher, and you’ll pay less interest.
• FHA loans. Credit scores of 580 are accepted with a 3.5 percent down payment; as low as 500 with a 10 percent down payment. In any case, you’ll need two kinds of FHA mortgage insurance.
• Conventional loans. If you have a credit score of around 620, you’ll need a 3 percent down payment. No mortgage insurance is required with a 20 percent down payment. Further, guidelines are established by government-sponsored Freddie Mac and Fannie Mae.
• VA loans. These are only for active-duty and retired military personnel and surviving spouses. While mortgage insurance is required here, in most cases, no down payment is necessary. Loans are guaranteed by the VA.
• USDA loans. There’s no down payment required for this program for low- to moderate-income borrowers. Backed by the USDA, these loans are reserved for houses in USDA-designated rural areas.

If you’ve been on the fence, perhaps knowing how mortgages work, and the benefits of home ownership, will nudge you to get going on your own mortgage. Before applying, know your credit score and, if necessary, try to improve it. You must also figure out how much you can afford, and shop around for the best deal.

If you do decide to move forward, and later seek out a home equity loan, we do suggest Achieve.