A mortgage is one of the biggest debt obligations most people will take on in their lifetime. Understanding what a mortgage is and how it works can help make the process of buying a home more manageable.
A typical mortgage payment includes principal, interest, taxes and insurance (PITI). Each month your loan balance will decrease as you pay off your debt through a process called amortization.
1. The Basics
A mortgage is a contract between you and a lender to borrow money to buy a home. It gives the lender the legal right to take your property if you don’t meet the terms of your agreement, which is typically to repay the money you borrowed plus interest over time. Mortgages are the most common way that people finance the purchase of a home.
A mortgage loan is one of the largest and longest-term loans you will ever make. It’s an important financial decision and should be considered carefully before taking out a mortgage. The mortgage process can seem intimidating and complicated, especially for first-time homebuyers.
There are many different types of mortgages available, and each has its own unique features. However, there are some common features of all mortgages. These include:
Monthly mortgage payments usually consist of four components: principal, interest, taxes and insurance. The principal is the specific amount of the loan that you borrowed to buy your home. The interest is the cost of borrowing that is calculated each month and is often expressed as a percentage rate. The taxes and insurance are the amounts that are paid into an escrow account to pay for these expenses when they become due.
These expenses are included in your monthly mortgage payment to help you avoid paying them out of pocket and keep your payments as low as possible. You should always compare the total costs of a mortgage to the cost of renting in your area before making a final decision.
Mortgages are a popular form of financing because they allow you to own your home without having to come up with all the cash upfront. They also offer lower interest rates than personal loans, and you can usually get a mortgage for up to 100 percent of the value of your home.
Mortgages are often the most expensive way to finance a home, but they can be a good choice if you don’t have the cash to purchase your home outright. It is important to focus on finding a mortgage that you can afford given your other priorities, and to pay off your mortgage as quickly as possible to minimize the amount of interest you pay.
2. Getting Pre-Qualified
Getting pre-qualified is a common step for buyers to take before beginning the home buying process. It helps borrowers sort out their finances and determine the size of mortgage they can afford, as well as understand different loan options and interest rates.
It’s typically a quick and easy process that can be completed online or over the phone with a lender. The lender will review the borrower’s credit history and score, income, debt, and other information to determine what they might qualify for based on their unique situation. This helps a buyer narrow down their home-buying search and gives them an idea of the range they can comfortably afford to buy in their desired area.
A prequalification also doesn’t require a formal application, making it an ideal first step for those who aren’t sure they’re ready to commit to the home buying process yet. Additionally, the prequalification process usually uses what’s known as a “soft inquiry” to pull a borrower’s credit report, meaning it won’t negatively affect their credit scores.
If you are confident that you are ready to begin the home-buying process, a mortgage preapproval can help speed up the timeline by giving buyers more time to shop around for a better deal. During this process, the lender will review the full mortgage application and supporting documents to ensure that there are no roadblocks in obtaining a loan approval.
While it may seem like a big commitment to go through the mortgage pre-approval process, the end result is a letter that can be used during the home-buying process to show sellers that you’re a serious buyer. This can be a great way to beat out other potential buyers and make the offer they submit more appealing to the seller.
It’s important to note that mortgage pre-approval is not a guarantee of loan approval. A borrower’s actual loan amount will be based on a number of factors, including the property’s price, local housing market, and the loan terms that work best for their budget. The final decision will ultimately be made by a lender’s underwriter, who will examine all of the documentation and evidence that the borrower can pay back their loan.
3. Getting Approved
When you get preapproval, your lender will examine your financial profile and credit history. You will need to submit a few basic documents, including proof of identity, income through pay stubs and bank statements and permission for a credit check. This stage of the mortgage process can be a bit time-consuming. To speed up the process, you should prepare ahead of time by checking your own credit reports and scores to make sure everything is up to date and accurate.
Once you have completed this step, you will receive a letter that states the maximum amount of mortgage financing the lender will offer you. The letter will include estimates of your interest rate, monthly payment and closing costs. This information will be invaluable as you look for a home. It will help you stick to your budget and avoid spending more than you can afford.
Getting preapproved for a mortgage also gives you leverage when making an offer on a home since the seller will know that you are a serious buyer. It can give you a leg up over other prospective buyers in a competitive market and could ultimately save you thousands of dollars in interest payments over the lifetime of the loan.
In addition to looking at your credit score, a lender will consider your debt-to-income ratio, your employment and housing stability, your assets and equity and the amount of funds you have available for the down payment and closing costs. Lenders are looking for borrowers who can afford to repay the loan and have the money to do so over the long term, even when rates increase.
During the preapproval process, lenders may request additional documentation or changes to the information you provided on your initial application, which can add to the length of the processing time. You can submit a mortgage application with more than one lender, but it is advisable to limit the number of lenders you work with to keep the amount of hard inquiries on your credit report low. NerdWallet advises that you should only apply for mortgages with lenders you trust and have been working with for a good while.
A mortgage is the largest financial obligation that most Americans will ever assume. It’s important to understand the closing process, also known as “settlement,” so that you don’t wind up paying more than you should or signing something you don’t fully understand.
On closing day, you’ll sign several legal documents that confirm your understanding of the terms of your mortgage loan. For example, you’ll sign a promissory note saying that you agree to repay the amount you borrow plus interest. At the same time, you’ll also sign a security instrument that pledges your home as collateral for the debt. In many states, this is called a deed of trust. You’ll also sign a variety of affidavits and declarations.
You’ll also need to provide documentation of your income and employment, as well as other items such as bank statements, tax returns and paycheck stubs. Some lenders may also require a preliminary home inspection, an appraisal and additional verifications. Generally, the more information you can supply to the lender early in the loan application process, the faster your mortgage can be approved and closed.
It’s usually best to wait until after closing to make major purchases or open new credit accounts. Lenders typically flag all new inquiries on your credit report, so opening any new accounts could delay your closing and cause you to incur extra fees. In addition, you should avoid making large deposits or receiving cash gifts from family members, as these can impact your ability to qualify for a mortgage.
Finally, you’ll need to show proof of homeowners insurance coverage and pay the closing costs, which can run 2%-5% of your mortgage loan. Closing costs may be negotiated with the seller, and you can usually pay them in the form of a cashier’s check.
Upon completing the closing process, the lender will transfer the money to the seller, and you’ll receive the keys. In the meantime, your real estate agent can schedule a final walkthrough to ensure that all aspects of the property are in good condition before you move in.