A mortgage is a loan that helps in buying a house. This type of loan is secured, and the house itself acts as collateral. The borrower is technically not the owner of the property until the mortgage is paid in full. If the borrower cannot pay the mortgage and defaults on loan, the bank will sell the house. A mortgage is a long-term loan. Usually, the mortgage terms are 15, 20, or 30 years. Most often, mortgage payments are made once a month. The monthly payment consists of both principal and interest charges. Most mortgage types require a down payment.
Major types of mortgages
- Fixed-Rate Mortgage, as the name implies, comes with a fixed interest rate throughout the life of the loan. The interest rate is set before the loan agreement is executed and remains the same without the possibility of changing. Regardless of changes in the market and real estate prices, monthly payments for fixed-rate mortgages do not change for 15, 20, or 30 years. This type of mortgage is suitable for borrowers who prefer to have stable monthly mortgage payments.
- Adjustable-rate mortgage (ARM). Adjustable rate mortgage has an ever-changing interest rate. The interest rate can be both rising and falling. However, changes do not occur immediately after the borrower enters into a loan agreement. Usually, lenders offer an initial fixed-rate period for this type of mortgage. Repayment terms for adjustable rate mortgages are often specified as 5/1 or 7/1. In this case, "5" means five years of the fixed rate period, and "1" means that the interest rate will be considered as an object for changes once a year after five years from the beginning of the life of the mortgage. The interest rate for adjustable rate mortgage depends on the standard financial index that is established by the Federal Reserve or the Secured Overnight Financing Rate (SOFR).
- Balloon mortgage is the riskiest type of mortgage. At the beginning of the life of the loan, monthly payments are relatively small and gradually begin to increase by the end of the loan term. This type of mortgage may be suitable for borrowers who expect to receive a higher income in a few years. Also, some borrowers choose balloon mortgages for future refinancing when the loan term ends.
- Reverse mortgage is only accessible for borrowers over the age of 62. This type of mortgage implies that a credit union or another financial institution pays monthly payments to a pensioner during their lifetime. However, after the borrower's death, the property becomes the property of the lender. If, after all, the borrower decides to refuse to transfer the property to a bank or lender and wants, for example, to transfer the property to inheritance, then they will need to return the amount paid to the bank with the addition of interest and terminate the contract.
- VA loan is a mortgage guaranteed by the U.S. Department of Veteran Affairs. This loan is not taken by the state but is insured by a state organization. Thanks to this, eligible veterans can get a mortgage without making any down payment. Some other types of mortgages also allow the borrower not to make a down payment. However, in this case, the lender requires the borrower to pay private mortgage insurance (PMI) in addition to monthly mortgage payments. With a VA loan, the borrower does not need to pay PMI. VA loan also has an interest rate lower than other types of loans. If the borrower has difficulty paying the mortgage, they can ask the VA for help.
- FHA loan is a mortgage that is guaranteed by the state organization Federal Housing Administration. This mortgage program is most suitable for those borrowers who are buying their first home. FHA home loan requires a credit score less than other types of mortgages. Moreover, the average down payment for this type of loan is 3.5%.
- USDA loan is a loan that is guaranteed by the state organization, the U.S. Department of Agriculture. This type of loan allows borrowers with low or moderate income to buy housing in select rural communities. USDA loan doesn't require any down payment and does not have a maximum purchase price. Moreover, the interest rate for this type of loan is relatively low. Registration of such a loan requires more time as the property is checked for eligibility.
- Jumbo loan is a mortgage with a property value limit higher than a traditional mortgage. The maximum value of the real estate for a jumbo loan is higher than the value that is set by the Federal Housing Finance Agency (FHFA). This loan has a high-interest rate and a larger down payment than other types of mortgages.
How to get a mortgage?
Requirements
Each type of mortgage has its minimum credit score requirements. A conventional loan, that is, a mortgage that is not guaranteed by any government agency, usually has a requirement of at least a 620 FICO credit score. FHA loan, as a loan aimed at young families buying their first property, has lower requirements, namely a 580 credit score. VA loan also requires at least a 580 credit score but still requires veterans to prove their eligibility. USDA loan requires a real estate check for eligibility and at least a 640 credit score. The jumbo loan has the highest requirements for a borrower's loan, at least a 700 credit score.
The application process
Modern mortgage lenders offer potential borrowers to go through the mortgage process and underwriting process online. However, the process of evaluating the house that the borrower plans to purchase does not take place online. The online process allows the borrower to get pre-qualification and find out the conditions of the future mortgage. To apply for a mortgage, a potential borrower needs to go to the lender's website and click on the "Apply" or "Get Started" button. Next, the borrower needs to enter information about themselves, namely their name, phone number, home address, email, and SSN. In the next window of the application form, the borrower needs to fill in information about whether they own real estate and whether they have another mortgage. Next, the borrower needs to fill in information about the desired property, namely the address, the purchase amount, and the type of property. After that, they will need to provide information about employment, annual income, and other sources of income. After filling out the application by the borrower, the lender makes a credit check using the SSN, and within a couple of hours, the borrower receives a response.
To confirm the identity, income, and timely payments made for rental housing or a past mortgage, the financial institution may ask the borrower to upload any of these documents:
- Utility bills;
- Proof of benefits received;
- P60 from the borrower's employer;
- Bank statements for the last 3-6 months;
- Tax returns SA302 form;
- Passport, driver's license, or state-issued ID;
- Council Tax;
- Insurance policies.
How to Choose a Lender?
Before choosing the right lender to apply for a mortgage, the borrower needs to make sure that they have a good credit score, have had no bankruptcies in the last seven years, and can show that they have made on-time payments for renting current housing or a past mortgage. All these will have a positive impact on the conditions that the lender can offer. The better the borrower's credit history, the lower the interest rates will be. There are several types of mortgage lenders:
- Direct lenders are banks, credit unions, online lenders, and other organizations that directly provide borrowers with a mortgage.
- A mortgage broker is an independent professional with a license who acts as an intermediary between the lender and the borrower. For their services, they most often ask for 1% to 2% of the loan amount.
- Correspondent lenders issue loans themselves, as do direct lenders. However, correspondent lenders always almost immediately sell the loan issued to a larger organization.
- Wholesale lenders never interact with borrowers directly. Such lenders themselves use the services of a mortgage broker to search for borrowers.
- Portfolio lenders originate and fund their client's bank deposits so they can hold on to the loans.
- Hard money lenders are private investors who issue short-term loans secured by real estate. They most often offer higher rates and monthly payments.
After the borrower has chosen the type of lender that suits them, they need to familiarize themselves with as many mortgage offers as possible. First, a potential borrower needs to study what types of mortgages are offered by lenders because some lenders may not provide customers, for example, with a jumbo loan.
When the borrower has decided which lenders are suitable for them and what types of mortgages they offer, they should apply for pre-qualification from all lenders. Most often, all credit conditions are unknown before the borrower receives approval of the loan application. Having studied all the offers, the borrower should compare interest rates, repayment terms, and other conditions. The best lender for obtaining a mortgage will be the one that offers an interest rate lower than others. Also, the borrower should pay attention to the size of other fees such as closing costs, property tax, homeowner insurance, and others.
How to pay the mortgage back?
Before taking out a mortgage, a potential borrower should familiarize himself with all the additional expenses that a mortgage requires. Besides the principal amount, which is the amount that the borrower takes from the lender, the borrower still needs to pay interest, property tax, homeowners insurance, and mortgage insurance.
The interest rate is individual for each borrower as it depends on creditworthiness, the loan term, and the amount of the property value. The average interest rate for a 30-year mortgage is 5.57%. A mortgage with a term of 15 years has an average interest rate of around 4.82%. Adjustable rate mortgages, most often in the fixed-rate period, have an interest rate of about 4.284%.
Most lenders create an escrow account for borrowers in which they keep the property tax on real estate paid by the borrower. When the property tax payment deadline arrives, the lender simply pays the tax from this account. Property tax payments are added to monthly mortgage payments.
The escrow account is also used by the lender to collect payments for homeowners insurance. This insurance protects the owner of the house and the lender from disasters, fire, and other incidents that can ruin the property. With the help of an escrow account, the lender pays the insurance provider for insurance. Payments on such insurance are also included in monthly mortgage payments.
Private mortgage insurance (PMI) payments can also be included in the monthly bill. However, these payments should be made only by borrowers who have made a down payment below 20%. This does not apply to borrowers who have taken out a mortgage with a VA loan.
To find the best credit conditions for a mortgage, the borrower should regularly monitor options for refinancing the loan. Refinancing can help the borrower lower the interest rate and monthly mortgage bills.
For the correct calculation of their mortgage payments, the borrower is recommended to use the mortgage calculator. Many online lenders provide users with such a calculator. In the calculator, the borrower needs to enter the loan amount, interest rate, and mortgage term. Knowing in advance what payments to expect, the borrower will be able to use his budget correctly and effectively.
To reduce the mortgage term and thereby reduce the interest payment at the end of the mortgage life, the borrower can pay one extra payment once a year. To do this, the borrower can add 1/12 of the additional payment to the mortgage payment every month, thereby making one extra payment per year.
Legal regulations
The mortgage market is supported by several government agencies. These are the U.S. Department of Veteran Affairs, the Federal Housing Administration, and the U.S. Department of Agriculture. Each of these organizations offers mortgages with more favorable conditions for certain borrowers. Each mortgage that is issued with the help of these organizations is guaranteed by the state, so the interest rates for such mortgages are lower, and VA loans and USDA loans do not require a down payment. FHA loan, at the same time, requires a small down payment of 3.5%. The work of these state organizations is aimed at providing special segments of the population with affordable loans for the purchase of real estate.
