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westreet españolPurchasing your own home is a big step in life. The process has several steps and can be daunting, also it’s likely the most expensive thing you’ll buy in your life. It is important to understand the process and how mortgages work to make your home-purchasing journey a success.
A mortgage is a specific kind of loan specifically used for purchasing a home. Mortgages are secured loans, with the home being purchased serving as collateral until the loan is repaid.
Mortgages work similarly to most other loans, where a financial institution lends you money to purchase something, and then you repay the loan, with interest, over an agreed-upon period of time.
Like with other loan types, your monthly payments can vary significantly depending on loan factors such as loan length, interest rate, loan principal, and what kind of mortgage you obtain.
One of the difficulties in understanding mortgages is learning the definitions of all of the terms that appear when discussing mortgages. To help, consult this list of loan terms if you forget what a specific term means.
Making sure that you can afford your mortgage payments is incredibly important. If you stop making mortgage payments, the lender can foreclose your home. Finding out how much mortgage you can comfortably afford is important in preventing mortgage default, but how can you determine what you can afford?
A great place to start is by using a mortgage calculator. Plugging in a mortgage principal, interest rate, and loan length will create an estimated monthly payment you can use to determine how much home you may be able to afford.
It’s important to consider that your monthly payment will often be higher than what the calculator estimates, as it does not consider property tax, homeowner’s association fees, or private mortgage insurance (PMI) if it will be required.
There are many factors that contribute to the amount of mortgage that you can afford. The three factors that are part of all mortgages are your debt-to-income ratio, the interest rate of your mortgage, and the size of down payment you make.
Debt-to-Income Ratio
One of the most important factors in calculating the mortgage you can afford is your income and your debt-to-income ratio or DTI. Calculating your DTI is easy: add up your monthly debt payments, including any car payments, student loans, and credit card debt, then divide that number by your gross (pre-tax) income. Multiply this number by 100 to obtain a percent, and you have your DTI
When looking at getting a mortgage, it is important to factor your future mortgage payments into your DTI. As a general rule of thumb, keeping your DTI without mortgage payments under 28% is ideal. With mortgage payments factored in, 43% is a more realistic target to aim for.
Interest Rate
The interest rate on your mortgage will greatly affect the size of your monthly payments. A single percentage point can affect your monthly payments by hundreds of dollars. Changes in interest rates are nearly impossible to accurately predict, but if interest rates decrease after you obtain a loan, you can always consider refinancing your mortgage.
Down Payment
Making a larger down payment can significantly decrease your monthly mortgage payments. An important breakpoint to consider with down payments is 20% is a benchmark. This is because for many mortgages, a down payment smaller than 20% may require you to pay for PMI.
There are two types and several categories of mortgages, each designed to fit the needs of a different home-buyer profile.
Fixed Mortgage vs ARM Mortgage
All mortgages, regardless of category, are split into two main types: Fixed Rate Mortgages or FRMs and Adjustable-Rate Mortgages or ARMs. The difference between these two types of mortgages comes down to their interest rates.
With a fixed rate mortgage, an interest rate is offered by the bank or credit union and is ‘fixed’ for the life of the loan. The interest rate will not increase or decrease.
With an adjustable-rate mortgage, your interest rate can fluctuate depending on market factors, with a few important details to note. ARMs start with a fixed-rate period where your interest rate is fixed for a certain period of time, usually somewhere between 3-10 years.
After this period, the loan enters the adjustable period, where your interest rate is subject to change. During the adjustable period, your mortgage interest rate can change every six to twelve months for the rest of the duration of the loan.
Both fixed-rate mortgages and adjustable-rate mortgages have their pros and cons.
Jumbo Mortgage
Jumbo mortgages are mortgages that, due to their size and other factors, carry increased risk for the lender. This means that jumbo mortgages have stricter requirements for qualification including a lower DTI ratio, and they often require a higher down payment.
FHA Mortgage
FHA mortgages are insured by the Federal Housing Administration. This means less risk for lenders which translates to less strict requirements to qualify for this type of mortgage as a borrower. FHA mortgages do have specific standards that must be met:
VA Mortgage
VA mortgages are offered to active-duty US Military members, National Guard and Reserve service members, veterans, and eligible surviving spouses. VA mortgages have government backing like FHA loans, though they are backed by the Department of Veterans Affairs.
VA mortgages carry a number of advantages including low or no required down payments, no requirement of PMI, and often lower interest rates compared to traditional mortgages. If you are an active-duty member or veteran of the US Military, VA mortgages are a competitive option compared to other mortgage types.
USDA Mortgage
There is a third type of government-backet mortgage: the USDA mortgage. Backed by the US Department of Agriculture, USDA mortgages are designed to help low and moderate-income households purchase homes in eligible rural areas. USDA mortgages may cover up to 100% of the home cost, which means no down payment. Like FHA mortgages, USDA mortgages require that you occupy the home as your primary residence.
First-Time Home Buyer Mortgage
While not technically a separate type of mortgage, you may be eligible to receive a mortgage with more flexible requirements if it is the first time you are purchasing a home. First-time home buyers may have lower down payment requirements, more flexibility with credit scores, and less strict income requirements. WeStreet’s First Home Mortgage offers first-time home buyers mortgage options with zero down payment, no PMI, and low, fixed interest rates.
Land Loan
Looking to purchase a parcel of land? Land loans can help you purchase land that does not currently have a home on it. Land loans are considered riskier than mortgages, and as such they usually carry a higher interest rate, a higher down-payment requirement, and shorter loan lengths.
Construction Loan
Construction loans are intended to cover the cost of building a new home or overhauling an existing one. They function differently from mortgages, as the funds are released in a series of payments to cover ongoing construction costs rather than one lump sum. Once construction is complete, the loan must be repaid either in a lump sum or by obtaining a traditional mortgage. A Construction-to-Permanent Loan is also an option. This loan combines the construction phase and mortgage into a single loan.
Since construction loans are considered riskier than traditional mortgages, they often require a higher down payment and carry a higher interest rate.
Reverse Mortgages
Reverse mortgages are a special type of mortgage offered to homeowners 62 and older who hold most or all of their home’s equity. With a reverse mortgage you receive money each month in exchange for the equity you have in your home, essentially selling your equity in your home until the last occupant of the home permanently leaves or passes away.
Afterwards, the company through which the reverse mortgage was obtained must be paid back for the money they dispersed, plus interest. Usually, paying this balance is accomplished by selling the home. For more information about reverse mortgages, see this article from the FTC’s Consumer Advice website.
Obtaining a mortgage is a multi-step process during which you will be required to provide documentation to your lender indicating your employment status and history, current assets owned, other debts you carry, and other relevant information.
Purchasing a home is a lengthy process which you can read more about in our article here.
Understanding mortgages is essential for anyone planning to purchase a home. While the process may seem overwhelming at first, breaking it down into steps can make it much more manageable.
By familiarizing yourself with the process, you’ll be better prepared to choose a mortgage that fits your financial situation and long-term financial goals. Whether you’re a first-time homebuyer or looking to upsize, taking the time to research your options can help you find loan terms that work for you.
Purchasing a home is an incredibly exciting experience. Understanding the mortgage process will help you make informed decisions and approach the home buying process with confidence.
This article is for educational purposes only. WeStreet makes no representations as to the accuracy, completeness, or specific suitability of any information presented. Information provided should not be relied on or interpreted as legal, tax or financial advice. Nor does the information directly relate to our products and/or services terms and conditions.
