Finding a home for sale and planning your purchase should be an exciting task. However, all the financial terminologies that come with obtaining a mortgage can make it seem intimidating.
Getting a mortgage is a crucial step in purchasing your first home. But, the vast array of available financing options can be overwhelming to deal with, especially if you don’t have much knowledge about them. Taking the time to properly research the basics of property financing will help you save a significant amount of time and money.
Here are a few vital details for first-time homebuyers to better understand the mortgage process and make their first big purchase hassle-free.
What is a Mortgage?
A mortgage, in simple words, is a loan used to finance a property or land. To secure a mortgage, you enter into an agreement with a bank or lender who will give you the loan cash upfront. You will then pay back the amount over a set period of time until the loan is fully paid off.
In the event where you fail to keep up your repayments, the lender can repossess your home and sell it to get their money back.
What are the Different Types of Mortgages?
While you can find a wide array of home mortgage types in the market, the two most popular types are fixed-rate mortgages and adjustable-rate mortgages. Here’s a breakdown.
- Fixed-Rate Mortgage
As the name suggests, with a fixed-rate mortgage, the interest rate is fixed. Every monthly principal and interest payment remains the same for the entire loan’s length or until the loan is paid off.
- Adjustable-Rate Mortgage
The interest rate of an adjustable-rate mortgage or ARM can vary from year to year. ARMs can also be a hybrid of both adjustable-rate and fixed-rate. For instance, the lender or the bank will set your interest rate at five percent for ten years and then adjust it according to their practices.
As stated earlier, there many more mortgage plans. Make sure you ask your lender about them so you can choose the right one for you.
What are the Five Parts of a Mortgage?
There are five parts to a mortgage—collateral, principal, interest, taxes, and insurance.
- Collateral
- Once you enter into the legal agreement with a bank or lender, the house you plan to buy will be used as collateral for that agreement. In the event where you fail to pay back the loan, the lender will repossess your house through foreclosure and sell it to get their money back.
- Principal
- The amount of money you can borrow from the bank or lender is called the principal. To secure a lower principal amount, you can apply more of your funds to your home’s purchase price, known as a down payment.
- Interest
- Interest is what the lender charges for loaning you money. It is often expressed as a percent, which is referred to as the interest rate. The principal and interest together make up most of your monthly payments, which will reduce your debt over a fixed period of time.
- Taxes
- When you buy a home, you will have to pay a percent of your home’s value as taxes to the local community. These taxes go to helping the community with roads, education, etc.
- Insurance
- Just like there is health insurance to cover you when you fall sick, lenders require that you buy home insurance to cover natural disasters, fire, theft, etc.
Understanding how all these five components work will make understanding mortgages easier.
How to Get a Mortgage?
To begin with, you need to do some shopping around to get an idea of what is out there. You should choose a lender, decide the length of the loan, the type of loan, and the applicable loan fees, if any.
The first step is to have an idea of what your priorities are. Then seek quotes from a few different lenders and compare your options. Once you select a few lenders, the next step is to get pre-qualified for the loan. By doing so, your lender will let you know how much you can borrow based on your income, credit, and debt-to-income ratio, along with other pertinent information.
When you are serious about getting a mortgage and buying a specific house, the next step is to get pre-approved with a lender or bank. During the pre-approval process, the lender will take a closer look at your finances, including your employment, credit, income, and assets, to determine the amount you qualify for. After pre-approval, you will likely be considered a more serious buyer by home sellers.
When shopping around for a mortgage, it is a good idea to consider the mortgage’s entire cost and any additional fees involved in getting the mortgage. For instance, some lenders might charge an origination fee for the loan or charge prepayment penalties if you want to pay back the loan ahead of schedule.
Work Out How Much You Can Afford
If this is your first time getting a home mortgage, you will find it quite challenging to sift through all the financing options. The first thing you should do is decide how much home and mortgage you can actually afford.
If you can afford to put a good enough amount toward buying a house, you will be able to negotiate better with lenders and have more financing options. If you look for the largest loan, you will be at the risk of a higher risk-adjusted rate and mortgage insurance.
Never stretch yourself if you find yourself unable to keep up repayments. Your home purchase doesn’t end with the mortgage. There are additional costs associated with owning a home, such as household bills, insurance, council tax, maintenance, etc. And you don’t want to be house poor.
So, weigh the benefits of getting a larger loan with the risk and the interest rates.
While a good mortgage broker or banker will help you navigate the different programs and options, nothing will serve you better than understanding your own priorities for a home mortgage.
