Just as your home is your largest asset, mortgages are the largest, longest-term loan you’ll apply for. Most people don’t have the funds to buy a home in cash so rely on mortgages to fund their home purchase. We have plenty of blog posts discussing how to save for and finance your home but what exactly is a mortgage and how do they work? In this post, we’ll cover the basics of what exactly is a home mortgage.
What’s a mortgage?
A mortgage is a secured loan used to purchase a home or other piece of real property. Mortgages are offered by banks, credit unions, and other financial institutions. The home serves as collateral; if the borrower doesn’t make their monthly payments and defaults on the loan, the lender can reclaim the home and sell it to recoup their costs. Once you repay your mortgage in full, you’ll be the outright owner of your home.
What’s included in a mortgage payment?
Your monthly mortgage payment is split into four main categories: principal, interest, taxes, and insurance. Here’s how each one works:
Principal: the total amount you borrowed from the lender (minus the down payment you provided). Principal can also refer to the amount left remaining on your loan balance. A portion of each monthly payment is applied to the principal, reducing the amount owed over time.
Interest: the amount the lender charges you to borrow the principal. Most of your monthly payment is applied towards interest at the beginning of your loan term, and then switching to reducing principal in the final years.
Taxes: your lender may collect your property taxes, saving each monthly payment in an escrow account and paying it on your behalf when it’s due. If your lender does not offer this service, you will be responsible for paying property taxes.
Insurance: most lenders require home insurance as a condition of getting your mortgage. Also called homeowner’s or property insurance, this covers your home in case it’s damaged or lost in a fire or natural disaster. If you had a down payment of less than 20% (unless you have a VA loan), you may also need to buy private mortgage insurance as well.
How long are mortgages?
The length of time you have to repay a mortgage is called a ‘term.’ There are two common loan terms: 15-year and 30-year. The most common term is 30 years. In fact, about 90% of homebuyers choose a 30-year, fixed-rate mortgage (more on that in a moment). 30-year terms allow you to have lower monthly mortgage payments. In contrast, 15-year terms allow you to pay off your mortgage faster but will higher monthly payments. We dive into the differences between 15-year and 30-year mortgages here.
What’s a fixed-rate or adjustable-rate mortgage?
There are two main types of mortgages: fixed-rate and adjustable-rate. These terms define how your interest rate is calculated.
Fixed-rate mortgages are just as they sound; the interest rate remains constant over the life of your loan. You will pay the same amount of interest each month until you pay off your loan.
Adjustable-rate mortgages (ARM) have variable interest rates. Typically, they begin with lower interest rates that slowly increase at set intervals of time over the life of your loan. This variability means you’ll be paying different mortgage payments over time.
What types of mortgages are available?
There are several types of loan programs you can choose from. Each program has their own eligibility and down payment options and allow you to choose your loan terms. Here are the most common programs (please check with each loan provider to learn more about eligibility requirements):
Conventional mortgages are the most common loan product. They’re managed the Federal Housing Finance Administration (FHFA) though commonly associated with Fannie Mae/Freddie Mac. These loans require a credit score of 620 or higher and a down payment of at least 3%.
FHA loans are insured by the Federal Housing Administration. FHA loans are popular with first-time homebuyers and allow borrowers with credit scores of at least 580 to put 3.5% down (borrowers with credit scores between 500 and 579 must put down at least 10%).
VA loans are administered by the U.S. Department of Veterans Affairs and are exclusive to eligible active-duty and retired military service members and surviving spouses. One of the main benefits of VA loans is there’s no down payment requirement and mortgage insurance is not required.
USDA loans are insured by the U.S. Department of Agriculture and are available for homebuyers in designated rural and suburban areas. There’s no down payment requirement and borrowers must meet income requirements.
The more you understand about mortgages, the better you’ll feel about finding the right option for your financial situation. At Hayden Homes, we want to make sure that you secure the financing option that’s right for you and your situation. This post should give you the foundation you need to confidently speak with a lender to find the right loan program for you.
We’re excited to work with you to find your dream home. Whether you’re looking in Idaho, Oregon, or Washington, our team can help you move into a home that’s just right for you at any stage in life. Contact us today.