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Understanding Mortgages

Let’s face it. House hunting is the fun research that most people think of when contemplating buying a home. You learn about neighborhoods. You decide on numbers of desired bedrooms and bathrooms, look at the condition of the property and weigh the importance of finishes. School districts and nearby amenities may sway your decision. You research real estate agents and the value of working with a professional or taking your chances on your own. You envision yourself living in the new home with endless sunny days filtering in through those nice big windows. Then the question comes: “Are you pre-qualified?”

Unless you plan to pay the entire amount yourself, you’re going to need to get a mortgage loan to help with your home purchase. And this, folks, is where the confidence in what to research next often runs out. At what point do you get pre-qualified? How do you judge which is the right mortgage company? What kind of mortgage program should you ask for? How much money do you need to have saved? What are the fees? Does a good interest rate require negotiation skills? How long does it take to get approved and what if you get rejected? Can you just show the mortgage company an app on your phone and walk out the same day with keys to your new home?

In this series we’ll examine 5 steps to turning yourself into a more successful mortgage candidate.

Step One: Research

The Benefits of Research

The more you understand entering into your mortgage pre-qualification, the more comfortable you’re bound to be through the mortgage approval process. Following are some areas of focus that should help you get underway.

First Things First… Where to Start

The first step in house hunting ought to be mortgage pre-qualification. Real estate agents and home owners are likely to ask you whether you’re pre-qualified because they don’t want to waste time showing you the house, or talking offers, until they know that you’re deemed capable of making a home purchase.

Understand Your Needs

The best chance a mortgage company will have of meeting your needs is if you can clearly state what they are. You don’t have to become an expert on every mortgage product out there, but you are an expert on your personal situation. That is exactly what your loan officer is looking to learn from you so they can turn around and give you solid professional guidance.

They’ll want to understand:

  • Your debt load compared to your income.
  • Your credit history.
  • What amount of monthly mortgage payment you would be able to pay consistently and comfortably.
  • How much money you have already saved to cover closing costs and down payment.
  • What is most important to you: low interest rates; low monthly payments; low down payment; using your VA benefits; not having to pay monthly mortgage insurance; not having to pay any mortgage insurance; getting assistance to buy your first home; seeing the house as a short term investment; planning to stay in the home for as long as possible; downsizing; upsizing; paying the loan off as fast as you can, etc.

It’s Okay. Play.

Mortgage calculators range from simple to complex, depending on where you look and how involved you want to get. Play around. Take a look at different ideas and get a feel for what that would mean for your wallet. It’s a good idea to keep in mind that mortgage calculators are broad brush estimating tools and may not take all of the facts into consideration. Still, in playing around, you may pick up on trends in one mortgage product or another that will help you to know what you’re looking for or inspire good questions to ask.

Mortgage Payments Calculator
Payments Calculator

How much will my payments be?

 

Affordability Calculator
Affordability Calculator

How much should I borrow?

 

Rent vs. Buy a Home Calculator
Rent vs. Buy

Should I think about buying a home instead of renting?

The more informed you are when you enter into your mortgage pre-qualification, the more you’ll be able to help get the kind of results you want. Poke around. Read up. And the next step and topic for next week… Ask Questions!


Understanding Mortgages

You’re a good comparative shopper. From the grocery store to the financial calculator, you’re sizing up your options and making the wise choice for your wallet. Naturally, when looking at whether it makes sense to rent a place or buy a home, you do your research. And when you do, you keep finding people talking about “building equity” as a good reason to buy a house. Why? What’s so special about this equity business?

What is Home Equity?

You can think of Home Equity as the amount of the property you own that’s left when you take away the amount of the debt you have against it. For example, the red section below is the home’s equity:

A mortgage is a loan where you use your property as collateral, meaning if you fail to pay your debt, you hand over your property instead. That’s called Foreclosure and is generally considered no fun so let’s imagine for this example that you do continue to pay your bills.

Every time you pay that mortgage, a portion of that money goes toward the principal balance (there are mortgage programs that don’t work like this but they’re specialized “interest only” mortgage products and we’re going to assume that you didn’t get one of those for the sake of this example). Principal Balance is a fun way of saying “the amount that you borrowed.”

So, every time you make a payment, the amount that you borrowed goes down a little bit. It’s a trickle at first, but as time goes by that widens to a stream and your principal balance really starts shrinking.

The retail value of your property (meaning how much you could sell it for) will fluctuate with the mood of the markets and home buyer seasons, but history says that eventually that value should go up. Your potential selling price goes up while the amount that you owe gets paid down. This difference is your home equity.

What Does This Have to Do Deciding Whether to Rent or Buy?

The simplest way to look at home equity is as an investment. Instead of putting your money in the stock market or a savings account, you’re investing in your property. That’s why people talk about home equity when they’re comparing renting against buying. When you rent, your money is covering someone else’s mortgage, if they have one. They are the one building equity on the property that you’re living in.

What is Home Equity Good For?

That is a question with many possible answers. Some people pay off their mortgage and live happily ever after knowing that they have that equity there should they need to draw money against it in case of an emergency, college tuitions, etc. Some people choose to draw on their equity through refinancing or adding a home equity loan or home equity line of credit, which can be less expensive options than credit cards. One person’s needs and goals will be different from the next but building equity is a nice way to keep options open in case of those life events with large dollars signs attached.

 


Understanding Mortgages

If you look around the internet you’ll see “20% down payment” mentioned a lot. That must be the standard amount of money you need to save up in order to buy a house then, right? Your bank account and savings plan may be relieved to learn that there are plenty of down payment options, and yes, you can absolutely buy a home with less than a 20% down payment.

Well then, why is everybody obsessed with 20%? The quick answer is that it’s simpler to use as an example than mortgage options with a lower down payment. 20% down payment is the typically accepted level where you can get a mortgage without needing to purchase mortgage insurance. Mortgage insurance can be paid up front and/or spread out in monthly payments, so for the sake of showing a more attractive monthly payment and lower closing costs, or just keeping things simple on a mortgage calculator, 20% tends to be a default. That’s all. Just an easier set of numbers to start with.

“What does this mean for me?”

Don’t count yourself out because your savings account isn’t close to 20% of the price tag on the home you want. Conventional mortgage loans offer 3% down payment options. Government programs like FHA, USDA-RD and VA mortgage loans allow for low down payments and in some cases, depending on eligibility factors, no down payments. You have plenty of options.

This is where it makes sense to speak with a mortgage loan officer to take a look at your options. Bring your questions and talk about your goals. Is a low down payment the most important factor or are you able to put a little more money down up front in the interest of having lower monthly payments? How do these figures line up when you add closing costs to your considerations? There is no single right answer, but once you take a look at your options you may see the solution that works best for you.


Understanding Mortgages

The inspection vs. the appraisal. They both require a professional to walk through the property. Both tend to happen early in the home purchase process. Both point out potential flaws. So, what is the difference between a home inspection and an appraisal?

Magnifying glassYou’ve chosen the home. You made an offer, it was accepted, and a contract now bears your signature. There was a section in the contract that said you intend to have an inspection done on the property. Why then is your mortgage company talking about also hiring an appraiser? In short, they’re two different services that serve very different needs.

Inspection
A property inspection primarily benefits the borrower. You hire a professional with a keen eye for trouble spots to go through the property with a figurative magnifying glass and provide you with a report of everything that could cause you grief. A property inspector isn’t going to be impressed by a new coat of paint and good furniture staging. It’s their duty to find the flaws and make you aware of what that could mean for your pocketbook or health. The inspection report is turned over to you, and depending on the findings, can be a negotiating tool between you and the seller.

Appraisal
A property appraisal is based on recent sales of similar properties in the area and informs your mortgage company of the estimated retail value (what it could sell for) of the property and also alerts them to potential areas of trouble. Since a mortgage is a loan where the house is used as collateral, the mortgage company needs to make sure that there is enough value in the property for this loan to be a good risk. Some mortgage programs also have guidelines that require certain parts of the property to be in good repair. Depending on the findings, the appraisal can also serve as a negotiating tool with the seller.

While the inspection tends to be optional, it is generally considered a good idea to purchase one so you won’t be blind-sided by costly or harmful issues that may be hidden from the common eye by a fresh coat of paint. Ultimately, that decision is yours. The appraisal is a necessary step in the mortgage process, so resign yourself to that cost. In the end, as you relax in your new home after move-in day, it can be argued that both up-front expenses were worthwhile.


Understanding Mortgages

If you've ever heard your loan officer mention something called a "pity payment" and scratched your head trying to figure out where the need for "pity" came into the equation, you're not alone. What they were really saying was "PITI," and they were talking about Principal, Interest, Taxes and Insurance, which are the four main components that make up a typical monthly mortgage payment.

While PITI is the typical, and commonly assumed makeup of a mortgage payment, some loan programs could include other elements. Based on your property and loan type, your monthly payment may also include a common/maintenance charge, homeowners' association fee or mortgage insurance. For the most part, though, PITI is what you'll be looking at when planning your mortgage and the monthly payments to come.

 

Let's take a closer look at a typical PITI monthly payment breakdown:

PRINCIPAL: The principal is the amount that pays back and reduces the mortgage loan balance. As time passes, the amount you pay in principal each month will increase as the interest amount decreases.

INTEREST: Interest is the ongoing cost of borrowing the money in a mortgage loan. As time passes, the amount you pay in interest each month will decrease while the principal amount increases.

TAXES: Real estate or property tax amounts are decided through your property assessment. The taxes due for your property will be the same amount regardless of the size of your mortgage. The tax portion of your mortgage payment is typically held in an escrow account that makes sure your taxes are paid on time.

INSURANCE: Homeowners or hazard insurance amounts are decided by the coverage plan you choose with your insurance company. This part of the mortgage payment is not affected by the size of your mortgage. Insurance payments are typically held in an escrow account that makes sure your insurance is paid on time. Some loan programs also have mortgage insurance, which is affected by the size of your mortgage. Mortgage insurance is insurance for the lender, should you default on (stop paying) your debt obligation.


Pieces of a home puzzle

It's good to understand how this all comes together when you're considering how much you can afford and, if hunting for a new home, where you want to search. Imagine this scenario: You have a pre-qualification for a mortgage, the monthly payments are within your budget, and all you have to do is find the perfect home. You find that home, go back to your loan officer, and find that the monthly payments suddenly jumped up past your comfort level. What happened? Is your loan officer playing tricks?

Not at all. If you had been paying attention to property taxes while you were doing your home search you may have noticed that the property taxes on this must-have home were significantly higher than what had been estimated. Loan officers generally make it their business to get those estimations as close to local averages as possible but it can happen that a certain municipality happens to have a higher rate than the others around it. The same can happen with homeowners' insurance. Not all insurance companies have the same prices, and each property and situation will be just a little different. Your loan officer will do their best at estimating during your pre-qualification, but until you have those real numbers it's just a "best guess."

 

Too many details to keep track of? Should you throw your hands in the air and run? Well, ultimately that's up to you, but if you decide to see it through you'll be happy to know that you have allies. Your loan officer should be able to help you with any questions you have and supply you with information that you can read over at your pace. If you're working with a real estate agent and an insurance agent, they should be valuable resources for your questions as well. All of these professionals have made it their business to know this stuff inside and out, and they're there to help you. Bring your questions.

And now, knowing what you do, you can tackle this mortgage planning stuff with full awareness of how each of these pieces fit into your overall monthly payment picture. There's no need for pity here. Just some good old fashioned self-confidence, knowing that you've got this.


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