The mortgage process can be a confusing experience. There’s a lot of moving parts that can sometimes trip up even seasoned home buyers. Whether you’re buying your first or next home in Lodi, it’s a major decision.
Getting a mortgage is simply one step of many to purchasing a new home. Here’s what you need to know to understand what a mortgage is and how it works.
What is a mortgage?
A mortgage is a secured loan received from a bank or financial institution to buy or refinance a home. Mortgages help buyers purchase a home without having the cash upfront. If you fail to repay the loan, mortgages give lenders the right to claim your property.
Over time, as you make regular payments, you gain more ownership over your home. You’ll own it outright once the loan is paid off completely and the lender will no longer have any claim to your property.
How do mortgages work?
When you get a mortgage, your lender covers the purchase price on your behalf. In return, you agree to repay the lender the amount you borrowed with interest. The home is used as collateral to ensure you repay the loan. The lender will hold onto the deed until the mortgage is paid off.
Mortgages cover the remaining amount of a home’s purchase price minus any down payment you provide. For example, if you purchase a home for $500,000 and have a down payment of $100,000, your mortgage amount would be $400,000.
What’s included in a mortgage payment?
Your monthly mortgage payments consist of four main components: principal, interest, property taxes, and home insurance.
Principal: The principal refers to both the amount you initially borrowed and the amount you owe after making payments. A portion of each payment goes towards pushing this amount down over time.
Interest: The interest is what you pay your lender for providing and servicing your mortgage.
Property Taxes: If your loan has an escrow account, your lender may collect property taxes each month and hold them until your taxes are due. If your lender does not provide this service, you will be responsible for coordinating this payment each year.
Homeowners Insurance: Home insurance protects your home from unexpected damage or loss from a covered event. Most lenders require borrowers to carry home insurance. We cover how home insurance protects you in this post.
Private mortgage insurance (PMI): If your down payment was less than the customary 20%, you will be responsible for getting private mortgage insurance (PMI). This insurance protects the lender in case you fail to pay your loan. Some lenders will remove this requirement once you’ve acquired 20% equity on your home. Check with your specific lender for details.
What types of mortgages are available?
There are a few different types of loans that fall into two basic categories:
Fixed-Rate: Fixed-rate mortgages have interest rates that remain the same for the entire length of the loan. The majority of mortgages are fixed-rate. Lenders typically offer these types of loans as either a 30-year term or a 15-year term. It’s important to understand that you will pay more interest over the life of a 30-year term loan but the monthly payments tend to be smaller. In contrast, you’ll pay less interest and more of the principal balance in a 15-year term loan but the monthly payments will be higher.
Adjustable-Rate (ARM): In an adjustable-rate mortgage, the interest rate can change at specific intervals, causing your mortgage payments to fluctuate. The interest rates tend to be lower at the beginning of your term and then adjust to a new rate based on the current market interest rates. Your lender will provide a schedule for rate adjustments in your loan documents so you can be prepared.
These loan categories are the basis for several types of mortgage programs. Here are the most common:
Conventional mortgages: Conventional loans are backed by a private lender or bank and conform to loan limits set by the Federal Housing Finance Administration (FHFA). They usually offer better interest rates and more flexible terms than government-backed loans but they also require higher down payments and credit scores.
Government-backed loans: Government-insured loan programs like the Federal Housing Administration (FHA), Veteran’s Affairs (VA) or United States Department of Agriculture (USDA) loans are backed by a government agency. Eligibility requirements vary based on the loan program but usually have lower down payment and credit score minimums than conventional loans.
Jumbo loans: Jumbo loans are larger-than-normal loans that exceed conventional loan limits set by the FHFA. These loans can be used to purchase a primary residence or an investment or vacation property. Qualifying guidelines and loan limits vary by lender and location so you may need to shop around a bit more than with a conventional or government-backed loan.
How to qualify for a mortgage
Applying for a mortgage can be a lengthy and detailed process since it requires more documentation than other types of loans. Here are some factors lenders look at when reviewing your loan application.
Credit score and history: Your credit plays an important role in securing a mortgage. Lenders review your credit history and score to determine if you’ll be a responsible borrower. Lenders reward borrowers with a strong credit score and history with favorable interest rates, which can save you thousands over the life of your loan.
If your credit is less than ideal, start working on improving your credit score.
Income: Lenders want to know that you have stable and reliable income so you can repay your debt. You can verify this by providing copies of bank states for your checking and savings accounts, W-2s or 1099 wage statements, recent pay stubs, income tax returns, and any other documentation that shows your income.
Debt-to-income ratio: Your debt-to-income ratio (DTI) is your total monthly debt payments divided by your gross monthly income. Lenders use this ratio to make sure you have enough income to pay off your debt, including the new mortgage you’re applying for. Depending on your credit score, lenders typically require a DTI of 45% to 50% or below.
Down payment: Depending on the type of loan you get you’ll need to provide a down payment of at least 3-3.5% of the final purchase price. As noted above, your lender may require PMI if you put down less than 20%.
Understanding how mortgages work and the available options puts you in the best possible position as you look for the option that works best for your specific situation. Reputable lenders will be able to craft the right loan option for you and answer any other questions you may have.
When you’re ready to buy, we’re ready to help! FCB Homes is known for designing and building neighborhoods that enrich the lives of the families that live there. Visit FCBHomes.com to learn more about our new home communities in Lodi and Riverbank.