Here’s Everything First-Time Home Buyers Should Know About Mortgages
First things first: What is a mortgage?
Good question! The short answer is: a loan. The slightly longer answer is: a loan in which a piece of property or real estate is used as collateral. A mortgage loan makes it so a home buyer doesn’t have to pay the entire value of a piece of real estate at once. Instead, they pay a percentage of that value up front and a bank or mortgage lender covers the rest. The home buyer then pays back the loan, plus interest, until they own the property outright. If they stop buying back the loan, the lender can foreclose on (aka take ownership of) the home.
But while all mortgages are loans, “mortgage payments” can be made up of different components.
Most of the time, when people talk about their “mortgage payment,” they’re referring to the sum of monthly principal, interest, taxes, and insurance — also known as PITI. The principal and interest are pretty straightforward: Principal is the amount a homeowner has borrowed from a lender, and interest is essentially the cost of borrowing that money. Taxes refers to property taxes and are determined by the value of the home.
Insurance generally refers to two types of insurance: homeowner’s insurance and private mortgage insurance. Homeowner’s insurance protects against fire, theft, and other disasters, while private mortgage insurance is required for anyone who borrowed more than 80% of their home’s value. Some borrowers unbundle their taxes and insurance to pay them separately. Some don’t. It just depends on the home buyer’s specific needs and circumstances.
And there a lot of different types of mortgages.
There is no such thing as a one-size-fits-all mortgage. There are lots of different types of mortgages, designed to meet specific needs. The two main types of conventional mortgages, however, are fixed-rate mortgages and adjustable-rate mortgages. Fixed-rate mortgages have a fixed interest rate, which means the interest rate stays the same for the life of the loan. While an adjustable-rate mortgage has an interest rate that fluctuates (read: goes up and down) over the life of the loan.
The types of mortgages you qualify for depend on the particulars of your financial situation.
There are lots of different mortgages because there are lots of different potential home buyers. There are home buyers with stellar credit and there are home buyers still building credit. There are home buyers who want to put 20% down, and there are home buyers who don’t. The types of mortgages a home buyer qualifies for depends on their credit profile, income, and financial goals.
And you can only find out what you’re qualified for by talking to a lender.
Just like there are lots of different types of mortgages, there are lots of different types of mortgage lenders. Banks are the most traditional source of mortgage funding, but mortgage brokers and online lenders are increasingly common. When a potential home buyer meets with a lender, the home buyer will share information about their assets, income, and debt to determine what types of mortgages they qualify for and how much money they’ll be able to borrow.
Pro tip: Prequalification and preapproval are different things — and neither are a loan commitment.
Prequalification is an informal process where lenders give home buyers a general sense of what they’ll be able to borrow based on an overview of their financials. Prequalification doesn’t require the lender to verify the information the borrower has provided and, as a result, is not a loan commitment. Preapproval, however, does require a home buyer to provide proof of their financial history. While it’s still not a loan commitment — borrowers still have to go through the underwriting process — preapproval can help secure an offer in a competitive home market. It lets the seller know in-depth financial analysis has already been done and a mortgage loan is more likely to be issued.
There are mortgage experts for a reason.
Getting a mortgage can seem like a jargon-filled process — in part because it can be. Fortunately, the plethora of lenders means first-time home buyers can shop around to find the right expert to walk them through the process. Don’t be afraid to lean on them and ask questions when things are unclear!
