What You Need to Know About Home Mortgage Loans
What You Need to Know About Home Mortgage Loans
Home mortgages are a big step for anyone, but they can be especially overwhelming to first-time homebuyers. If you're like most people, the thought of buying your first home is both exciting and terrifying at the same time. If you're looking at homeownership in the not-too-distant future, let’s make sure you have a good understanding of the basics. Here's what you need to know about getting a home mortgage loan:
What is a Home Mortgage Loan?
A home mortgage loan is a loan that you take out with a bank or other lender to finance the purchase of your new home. When you take out a home mortgage loan, the bank essentially becomes the owner of your home until you pay off your entire mortgage or refinance it with another lender. Mortgages are typically 30-year loans.
It is important to know more about the different types of home mortgage loans. There are essentially four different kinds of home mortgage loans: conventional, FHA, VA, and USDA. We’ll explain more about each type in the following section.
Conventional: The most common type of home mortgage loans, conventional loans are issued by private lenders, not the government. Fannie Mae and Freddie Mac are two companies that routinely issue conventional loans. For a conventional loan, there are some requirements that must be met to qualify. Typically, to qualify for a conventional loan, you'll need a credit score of 620 or higher, a debt-to-income ratio of 45 percent or lower, and a cash deposit equal to twenty percent of the home purchase price.
VA Loans: If you're a veteran of the U.S. military or the spouse of one, you may be able to qualify for a VA loan. VA loans are offered by private lenders like banks and mortgage brokers and are guaranteed by the government. There is no down payment required to get a VA loan, and the interest rates are typically lower than for other types of home mortgage loans.
FHA Loans: FHA loans, backed by the Federal Housing Administration, are designed to assist people with lower credit, a higher debt-to-income ratio, and those who don't have as much money to put on a down payment. To qualify for an FHA loan, you should have a credit score of at least 500, a debt-to-income ratio no more than 56 percent, and a three or five percent down payment.
USDA Loans: If you plan to purchase a home in certain rural areas, you may be eligible for a USDA loan. A USDA loan is guaranteed by the U.S Department of Agriculture's Rural Development branch. To qualify for this type of home mortgage loan, you'll need to pay off your previous debts within the last twelve months and have an excellent credit history.
What is a Co-Signer, and When Do You Need One?
A co-signer is someone who trusts you and agrees to be responsible for your loan if you're unable to make the payments. You might need a co-signer if your credit and debt-to-income ratio don't align with the lender's requirements. If you have a co-signer, their income and credit history will be taken into account when the bank is deciding whether to approve your loan. A co-signer is usually a family member or close friend. If you default on your payments, they become legally responsible for your mortgage.
What Are Closing Costs?
There are multiple fees and charges associated with your residential real estate transaction, from lender fees to appraisals, inspections, escrow agents, property taxes, homeowner's insurance, and more. Closing costs, which are all of those fees combined, are paid out-of-pocket on closing day and generally run between two and six percent of the amount of your loan.
There are exceptions to the rule wherein some lenders may offer to roll your closing costs into your mortgage. Just remember that when you do that, you agree to pay interest on that money for the next 30 years, which can add up to substantial dollars over the life of the loan.
Shop for Different Lenders
Just like anything else, when it comes to getting a home mortgage loan, you want to compare your options. Different lenders offer different interest rates, loan products, and terms. When you interview different lenders, you have an idea of how closing costs fluctuate, the average interest rates, and the different terms. With this information, good credit, and a low debt-to-income ratio, you may be able to negotiate lower rates and better terms. You don't have to commit to the first lender you speak with - take some time to compare offers before making a decision. Sometimes, working with a trusted lender from a local bank like Eaton Community Bank, where you already have a working relationship, makes for a quick and smooth mortgage transaction.
Why You Need Pre-Approval on Your Home Mortgage Loan
One of the most important things you can do when shopping for a home is to get pre-approved for a mortgage. Pre-approval means that the bank or broker has looked at your credit history and determined how much money they're willing to loan you. Pre-approval also puts you in a better-negotiating position when you make an offer on a home because the seller knows that you already have financing lined up. When it comes time to actually purchase the home, getting pre-approved helps speed up the process - since all of your financials are already in order - and can even help you land a deal on the house you want. This is especially important in the current fast-paced home buying market we are experiencing now.
Pre-Approval and pre-qualification are not the same things. Pre-qualification is just a soft inquiry on your credit history. For pre-approval, you'll need to provide the lender with income verification and proof of assets. Pre-approval usually takes around 30 days, with an additional 30-60 days for closing.
The Documents You'll Need to Get Pre-Approved
You'll most likely need a few things to get pre-approved for a home mortgage loan:
- Your Social Security number and proof of income (W2 forms and pay stubs)
- Your bank statements and investment account balances for the last two months
- A copy of your driver's license
- Your past two years' federal income tax returns
- Proof of assets (investment account balances, bank statements)
How Your Mortgage Payments are Divided
Mortgage payments are typically divided into two parts: the principal and the interest. The principal is the amount of money you borrowed to purchase your home, while the interest is the lender's fee for letting you borrow that money. Your monthly mortgage payment will be a combination of those two amounts, plus any homeowners insurance or property taxes you may have to pay.
Fixed-Rate vs. Variable-Rate
There are two kinds of interest rates: fixed-rate and variable-rate. A fixed-rate mortgage, or FRM, is usually a thirty-year loan that has an interest rate that stays consistent for the full term of the loan. In other words, you'll know exactly how much your monthly mortgage payment will be from month to month until the very end of the term.
Variable-rate mortgages allow your lender to adjust the interest rate based on changes in market conditions - typically every six months or annually. As a result, your monthly payments start out low but will increase or decrease as often as every six months over the course of a variable-rate mortgage agreement.
Purchasing Points for a Lower Interest Rate
You can lower your monthly interest rate by pre-paying some of it in advance. Typically, one point is equal to one percent of the total amount of money borrowed on a home purchase transaction.
What is an Escrow?
An escrow is a third-party account that holds money collected by the lender to pay for your property taxes and homeowners insurance. Your monthly mortgage payment will include an amount set aside to go into your escrow account. The idea is that by having the money saved ahead of time, you won't have to worry about making those payments each year.
What is PMI?
PMI, or Private Mortgage Insurance, is an added insurance policy that helps protect lenders from losses in the event that you default on your loan. If you don't have the down payment of 20 percent that's required on your home purchase, or if your credit score is below 640, for example, you may be required to pay PMI each month until your loan-to-value ratio is less than 80 percent.
The Lender Requires an Appraisal and Inspection
Lenders require an appraisal to verify that your home is worth the price you're paying for it. In addition, a professional inspection can identify problems with the property's structure and provide information on how much it may cost to fix any issues down the road. If there are problems with the inspection, or if the appraisal is too low, you can try to negotiate, or you may have to cancel the contract and look for a new house.
A Final Check of Employment, Credit, and Bank Balance
It's crucial that you don't change jobs, finance anything, take out any loans or open any new credit cards, or spend large sums of cash prior to closing on your new home. This is because the bank will verify your financial situation again on closing day. If there are any significant changes, the bank can cancel their loan offer right up to the last minute before getting your keys.
Now that you know what to expect, it's important to consult with a lender and get pre-approved for a mortgage. Being an informed home buyer and knowing how much you can afford will position you in a better place to negotiate when you find the perfect home. When a buyer is prepared and understands the process, buying a home can be an enjoyable and exciting experience.