Jan 24, 2024

Home Loans 101: Understanding the Basics of Mortgages

Disclaimer: This article is meant for educational purposes only and is not intended to be construed as financial, tax, or legal advice. Pahlisch Homes always encourages you to reach out to an advisor regarding your own situation.

 

Promissory notes. Origination fees. Debt-to-income ratios. Dipping your toes into the world of home loans can feel more like diving headfirst into a confusing swirl of technical jargon and complex equations. That can be especially distressing when you’re trying to make such a big decision with so much money at stake.

Whether you’re a first-time home buyer or just in need of a refresher, we want you to feel empowered, not overwhelmed. That’s why we partnered with Hixon Lending — our preferred lender — to answer all your home loan questions.

We will walk you through the basics, demystify the pre-qualification process, and explain the differences between the types of home loans out there. All so you can feel confident as you move toward home ownership!

Starting With the Basics

What is a mortgage?

A mortgage is a type of loan specifically used to purchase real estate. In a mortgage agreement, the borrower agrees to pay back the loan amount plus interest to the lender over a specified period. Mortgages allow individuals to buy homes and pay for them over time, making homeownership accessible to those who can’t afford to pay the full price upfront.

What is a promissory note?

A promissory note is a financial document in which one party (the maker or issuer) promises in writing to pay a determinate sum of money to the other (the payee), either at a fixed or determinable future time or on demand of the payee, under specific terms. In the context of mortgages, the promissory note is separate from the mortgage itself but is an integral part of the loan transaction, representing the borrower’s promise to repay the amount borrowed to purchase the property.

What are mortgage interest rates?

Mortgage interest rates are the rates at which borrowers are charged for borrowing money from a lender to purchase property. The interest rate on a mortgage is one of the most crucial factors for both the borrower and the lender, as it directly affects the monthly payments and the total cost of the loan over its lifetime.

What is the difference between an interest rate and an APR?

The Annual Percentage Rate (APR) includes the interest rate and other costs or fees involved in procuring the loan (like origination fees or points) and is designed to give you a more comprehensive look at what you’re being charged annually over the life of the loan.

Can mortgage interest rates be negotiated?

Yes, mortgage interest rates can be negotiated — in certain situations. While lenders set their rates based on broader economic conditions and the borrower’s financial situation, there is often some room for negotiation. Not all lenders will move very much on their offered interest rates, but it’s always worth inquiring and negotiating. Even a small reduction in the interest rate can save you a significant amount of money over the life of the mortgage. Remember, everything is more negotiable if you have a strong credit profile and financial stability.

How often do mortgage interest rates change?

Mortgage interest rates can change frequently, sometimes even daily or multiple times within the same day. While the underlying economic factors can change frequently, most lenders will set their specific mortgage rates once daily. If the market is particularly volatile, lenders might adjust their rates midday. When shopping for a mortgage, it’s a good idea to keep in mind that the rate you’re quoted one day might not be available the next. Once you’ve found a rate that suits your needs, you might consider locking it in to protect against future fluctuations. A rate lock ensures that the lender will honor the quoted rate for a certain period, typically 30 to 60 days, regardless of what happens in the market.

Can I shop around for mortgage interest rates?

Yes! You can and should shop around for the best mortgage interest rates. Just like any other purchase, comparing offers from multiple lenders can help you find the most favorable rates and terms. By shopping around and comparing rates from multiple lenders, you can ensure you’re getting the best deal possible on your mortgage. It’s worth the effort, as even a small difference in the interest rate can significantly impact the total amount of interest you’ll pay over the life of the loan.

Are there different types of mortgage interest rates?

There are two main types of mortgage interest rates:

  • Fixed-Rate Mortgage: With a fixed-rate mortgage, the interest rate remains the same for the entire term of the loan, typically 15 or 30 years. This provides predictability in monthly payments.
  • Adjustable-Rate Mortgage (ARMs): An adjustable-rate mortgage features an interest rate that is fixed for an initial term but then fluctuates with market interest rates. The initial rate is often lower than that of fixed-rate mortgages, but there’s the risk of it increasing significantly over time.

What is the principal on a mortgage?

The principal on a mortgage is the amount of money that you borrow from the lender to purchase your home. It represents the actual balance of the funds provided to you to buy the property before any interest or additional fees are added. Understanding your mortgage’s principal is important because it directly impacts your monthly payments, how much interest you’ll pay over the life of the loan, and how quickly you build equity in your home.

What is home equity?

Equity is the portion of your home that you truly “own” — the difference between its value and the remaining principal on your mortgage. As you pay down the principal, your equity increases.

Who are the people that help me secure a mortgage?

There are four main parties involved in the process of securing a mortgage:

  • Loan Officer: A loan officer, or mortgage advisor, is a person who works directly with borrowers to initiate the lending process. They assess your financial situation, explain different types of loans, help you complete the application, and communicate the lender’s requirements. They are typically the main point of contact within the lending institution.
  • Title Officer: A title officer or company conducts a title search to ensure the property is free of issues such as liens or disputes over ownership. They also provide title insurance, which protects you and the lender from future claims against the property.
  • Underwriter: Once your application is submitted, it goes to an underwriter who assesses the risk of lending to you based on your credit, income, and the property’s value. They review all the documentation you’ve provided, check for compliance with lending guidelines, and ultimately decide whether to approve or deny your loan.
  • Appraiser: Hired by the lender, an appraiser determines the market value of the property you’re looking to buy. This ensures the lender isn’t lending more money than the property is worth.

Getting Pre-Qualified

How do I know how much house I can afford?

Determining how much you can afford to spend on a house is a crucial step in the home-buying process. It involves a thorough assessment of your finances to ensure you can comfortably manage your mortgage payments along with your other expenses. These factors include income, debt-to-income ratio, and down payment.

  • Note: A good general rule to follow is to keep your debt-to-income ratio at or below 50%, including your new mortgage.

Remember, while a lender might approve you for a certain amount, only you know your full financial picture and what monthly payment you’re comfortable with. It’s often wise to aim for a home that’s below your maximum budget to ensure you can comfortably afford it while still saving for other financial goals.

How do I calculate what my monthly mortgage payment will be?

To calculate your monthly mortgage payment, you’ll need to know the loan amount, interest rate, and term of the loan. The monthly payment typically includes principal and interest, but you should also consider other costs like property taxes, homeowners insurance, and possibly private mortgage insurance (PMI) or homeowners association (HOA) fees.

Can I buy a house with bad credit?

Having a low credit score can significantly affect your mortgage options and the overall home-buying process. Here are some potential consequences:

  • Higher interest rates
  • Higher down payment
  • Stricter loan terms
  • Loan denial
  • Limited loan types

Remember, while a low credit score can make getting a mortgage more challenging, it’s not necessarily an insurmountable obstacle. With the right approach and possibly some time spent improving your financial situation, you can increase your chances of securing a mortgage that fits your needs.

What does it mean to have/need a co-signer?

Having or needing a co-signer means that another person, besides the primary borrower, signs the loan agreement and agrees to take on the financial responsibility of the loan. This is common in situations where the primary borrower’s income, credit history, or debt-to-income ratio might not meet the lender’s requirements.

What do I need to prove in order to secure a home loan?

To secure a home loan, lenders typically require a variety of documents and proofs to assess your financial stability, creditworthiness, and overall risk as a borrower. While specific requirements can vary by lender and loan type, here’s a general list of what you might need to provide:

  • Proof of income
  • Employment verification
  • Credit history
  • Debt information
  • Asset information
  • Down payment
  • Identification
  • Purchase agreement
  • Appraisal & title information
  • Homeowners information

Lenders use this information to assess your loan application and determine whether you’re a good candidate for a mortgage. They’ll look at your ability to repay the loan, the stability of your income, your debt obligations, and how much risk they’re taking on by lending you the money. It’s a good idea to start gathering these documents early in the home-buying process so you can move quickly once you find a home you want to purchase.

When do I get pre-approved for a mortgage?

Getting pre-approved is a critical step in the home-buying process and should be done early to set a clear path forward. It’s a sign to all parties involved that you’re serious about buying and have done the necessary financial homework. It also provides peace of mind that you’re looking at homes you can realistically afford. Early pre-approval gets you:

  • Budget clarity
  • Credibility with sellers
  • Faster closing
  • Interest rate lock
  • Early identification of credit issues

What things could keep me from becoming pre-qualified or approved for a loan?

Several factors could hinder your ability to become pre-qualified or approved for a loan. Lenders assess your financial situation to determine the risk associated with lending you money. If they find issues that raise concerns about your ability to repay the loan, they might not approve your application. Here are some common factors:

  • Low credit score
  • High debt-to-income ratio
  • Unstable employment history
  • Insufficient income
  • Incomplete application or documentation
  • New credit lines or additional debt
  • Large or unexplained bank deposits
  • Negative financial events
  • Interest rate or market changes

Understanding and addressing these factors can improve your chances of getting pre-qualified or approved for a loan. If you’re denied, lenders are required to explain why, providing you with information that you can use to improve your financial situation and potentially qualify in the future.

What do I need to do if getting a new loan is based on a contingency?

If getting a new loan is based on a contingency, it means that the loan’s approval and disbursement are dependent on certain conditions or events being met. This is common in real estate transactions, where the purchase of a new home might be contingent on the sale of the current one. Here’s what you generally need to do:

  • Understand the contingency
  • Fulfill the contingency requirements
  • Document everything
  • Communicate with your lender
  • Request an extension if needed
  • Get legal and financial advice
  • Be prepared for any outcome
  • Confirm fulfillment and proceed

Contingencies are put in place to protect the lender and ensure that certain conditions are met before they commit the funds. While they can add an extra layer of complexity to getting a loan, understanding and proactively managing them can help you secure the financing you need.

What are some things I shouldn’t do while trying to secure a home loan?

While you’re in the process of securing a home loan, there are several things you should avoid doing. Certain actions can negatively impact your credit score, alter your financial profile, or raise concerns with lenders, potentially jeopardizing your loan approval. In general, you’ll want to avoid:

  • Changing jobs or becoming unemployed
  • Making large purchases
  • Opening new credit accounts
  • Closing credit accounts
  • Making late payments or defaulting
  • Making unusual bank transactions
  • Co-signing other loans
  • Ignoring lender communications
  • Not checking your credit report
  • Failing to lock in a rate
  • Not having adequate homeowners insurance
  • Changing your marital status

The period between your loan application and closing is sensitive. Lenders may check your credit and re-verify your financial information before finalizing the loan. Maintaining a stable financial profile and being responsive to your lender’s requests can help ensure the process goes smoothly. If you’re unsure about a particular action, it’s often wise to consult with your lender or a financial advisor first.

Understanding the Home Loan

What are the different types of home loans?

There are several types of home loans available, each with its own advantages, requirements, and use cases. The best loan for you depends on your financial situation, the property you’re buying, and your long-term goals.

  • Fixed-Rate Mortgages: The interest rate remains the same for the life of the loan (15/20/30 Year), which means you get predictable monthly payments.
  • Adjustable-Rate Mortgages (ARM): The rate is fixed for an initial period (e.g., 5 years), then adjusts periodically based on market conditions. An ARM often starts with a lower interest rate than a fixed-rate mortgage, which can be beneficial if you plan to sell or refinance before the rate adjusts.
  • FHA Loans: Federal Housing Administration loans offer a down payment as low as 3.5%, easier credit qualifications, and lower down payment requirements.
  • VA Loans: These are loans from the US Department of Veterans Affairs. They require no down payment or private mortgage insurance, offer competitive interest rates, and are eligible to veterans, service members, and surviving spouses.
  • USDA Loans: These loans are from the US Department of Agriculture. There’s no down payment required and they are eligible to rural and suburban homebuyers.
  • Conventional Loans: The down payment is typically 3-20% with flexibility in terms and conditions, plus no upfront mortgage insurance fees.
  • Jumbo Loans: These exceed the conforming loan limits set by Fannie Mae and Freddie Mac, and usually require a 10-20% down payment.
  • Interest Only Mortgages: For a certain period, you pay only the interest on the loan, not the principal.
  • Balloon Mortgages: Low payments for an initial period, followed by a large “balloon” payment for the remaining balance.
  • Home Equity Loans and HELOCs: Allows you to borrow against the equity in your home.

Each type of loan has its own eligibility requirements and considerations. It’s crucial to understand how each one works and to consider your own financial situation, how long you plan to stay in the home, and how comfortable you are with the inherent risks (like interest rate increases). Consulting with a mortgage broker or lender can help you understand which type of loan might be the best fit for you.

Are there benefits for first-time home buyers?

Yes, there are often various benefits, programs, and incentives specifically designed to help first-time home buyers. These can make purchasing a home more accessible and affordable. The exact benefits can vary by location and over time, but generally, they may include:

  • Lower down payments
  • Grants and assistance programs
  • Favorable loan terms
  • Mortgage credit certificates
  • Education programs
  • Special government programs: FHA, USDA, VA
  • State and local programs

To find out which benefits you might be eligible for, check with your local housing authority, a HUD-approved housing counselor, or a real estate agent familiar with first-time buyer programs in your area. Additionally, a mortgage lender can help you understand and apply for loans suited to first-time home buyers.

What is private mortgage insurance?

Private Mortgage Insurance (PMI) is a type of insurance that lenders require from most homebuyers who obtain loans that are more than 80% of their new home’s value. In other words, buyers with less than a 20% down payment are normally required to pay PMI. PMI protects the lender in case the borrower defaults on the loan and the home goes into foreclosure. PMI increases the cost of your home loan, but it can also make homeownership accessible sooner for those who can’t afford a large down payment. Understanding how PMI works and when it can be removed can help you manage your finances and potentially save thousands of dollars over the life of your loan.

How do I get PMI removed?

Some common ways to get private mortgage insurance removed include:

  • Automatic termination
  • Requesting PMI cancellation
  • Refinancing
  • Additional payments
  • Reappraisal

To start the process, contact your lender to understand their specific requirements and procedures for PMI removal. Keep good records of your payments, and if you’re making extra payments toward the principal, ensure your lender is applying them correctly. With careful planning and a bit of diligence, you can successfully get PMI removed and reduce the overall cost of your mortgage.

Does having a mortgage help with taxes? How?

Yes, having a mortgage can offer tax benefits under certain circumstances. The primary way a mortgage can help with taxes is through mortgage interest deduction, but there are other potential deductions and credits as well. Here’s how it generally works in the United States (note that tax laws can vary and change, so it’s always a good idea to consult with a tax professional):

  • Mortgage interest deduction
  • Property tax deduction
  • Points deduction
  • Home office deduction
  • Home equity loan interest

Having a mortgage can provide significant tax benefits, particularly in the early years when the majority of your mortgage payment goes toward interest. These benefits can make homeownership more affordable in the long run, but the exact impact depends on your personal financial situation and current tax laws. Always consult with a tax professional to understand how these rules apply to your situation and to plan the most effective tax strategy.

What costs or fees are wrapped up in the loan?

When you obtain a mortgage, certain costs and fees associated with the home buying and loan process can often be included (or “wrapped up”) in the loan amount, allowing you to pay for them over the life of the mortgage rather than upfront. However, this increases the size of your loan and the amount of interest you’ll pay over time.

Here are common costs and fees that are often wrapped up in the loan:

  • Closing costs, including loan origination fees, appraisal fees, credit report fees, title search and insurance, survey fees, and attorney fees
  • Points or discount points
  • Prepaid Items like interest, escrow accounts, or PMI
  • FHA, VA, or USDA loan fees, including FHA upfront mortgage insurance premium (MIP), VA funding fee, and USDA guarantee fee

While wrapping fees into your loan can reduce your upfront out-of-pocket costs, it’s important to understand the long-term implications. You’ll be paying interest on these amounts for the entire loan term, which could significantly increase the total amount you pay. Consider discussing your options with your lender and a financial advisor to make the most informed decision.

Whew! Okay, that was a lot of information to cover. But hopefully, after reading this post you’re feeling like you have a better idea of what’s involved in the process of securing a home loan. If you’re interested in buying a Pahlisch home and have questions about next steps, reach out to one of our New Home Specialists. We’d be glad to speak with you.

A big thank you to Hixon Mortgage for taking the time to walk us through the home loan basics! And don’t forget to follow us on social media for more tips and updates (Instagram, Facebook, Linkedin, Pinterest)

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