What is a mortgage? All you need to know about mortgage loans
Our goal is to give you the tools and the confidence you need to improve your finances. While we do receive compensation from our partner lenders, whom we will always identify, all opinions are ours. Credible Operations, Inc. NMLS # 1681276, is referred to herein as “Credible”.
People looking to buy a home rarely have enough money to pay for it up front. This is why mortgages are popular. They allow you to borrow money to buy a home, usually with a down payment, and gradually pay off the loan with interest. Up to 86% of recent homebuyers have financed their purchase with a mortgage.1
Here’s what you need to know about mortgages:
So what is a mortgage loan?
A mortgage is a loan you take out to finance the purchase or refinancing of your home. Here are some things to remember about a mortgage:
- It is secured by your home or other property.
- You pay it back over a period of time – typically 15 to 30 years.
- If you don’t make your payments at any time during the life of the loan, the lender can take possession of your home through foreclosure.
It is important to consider the costs before signing up for the loan. There are two main types of costs to consider:
- The initial costs: These are a one-time fee that you pay when you buy the house. They understand closing costs, which generally represent between 2% and 5% of the purchase price of your home, and the advance payment.
- Ongoing charges: These come in the form of a monthly mortgage payment, which you will make over the life of your loan. The payment usually includes a portion of your principal balance and interest. You may also need to purchase mortgage insurance if your down payment is less than 20%.
Types of home loans
The most common mortgages are conventional loans and government sponsored loans. The main difference between these types is who insures the loan.
- Conventional loans are managed by private lenders such as banks, credit unions and online institutions. Since conventional mortgages are guaranteed by mortgage agencies Fannie Mae and Freddie Mac, they must meet agency standards. In most of the United States, a compliant loan on a single family property must be less than $ 510,400, but can be as high as $ 765,600 in high cost areas.
- Jumbo loans are like conventional loans, but for homes that exceed these price limits.
You will also find government insured loans from private lenders, but they are guaranteed by government institutions:
- FHA loans are provided by the Federal Housing Administration. To be eligible, your credit score and down payment must meet FHA loan requirements. You will also need to pay for mortgage insurance at closing and for the duration of the loan if your down payment is less than 20%.
- VA loans are available to veterans and are insured by the US Department of Veterans Affairs. There is no down payment or private mortgage insurance requirement, although borrowers pay a financing fee.
- USDA loans are supported by the US Department of Agriculture. To qualify, you must meet income requirements and purchase a home in a “rural” area defined by the USDA. There is no down payment, but borrowers pay for two forms of mortgage insurance.
See: VA loan vs conventional loan: how to choose
How Mortgage Loans Work
When you take out a home loan, you sign an agreement that specifies your monthly payments, loan term, loan amount, mortgage rate, and other terms of the agreement. Each month you will send a payment to your loan manager.
- Advance payment: This is the money you pay up front to buy the home, and it’s expressed as a percentage of the home’s value. A larger down payment reduces the amount of money you need to borrow, which can help lower your monthly payments. A typical down payment is 20%, but you don’t always need that much, depending on your mortgage type.
- Credit score: The lender will partially base your mortgage rates on your credit rating. A score in the mid-700s or higher can help you get a good rate, but it’s still possible to get a mortgage with a lower score. On an FHA loan, the minimum credit score is 500 if you put at least 10% down or 580 with 3.5% down. Conventional lenders tend to look for scores of 620 or higher.
- Debt-to-income ratio: DTI calculates how much of your monthly income goes to debt, including your mortgage payment. If you earn $ 6,000 a month and $ 2,400 is spent on debt and mortgage payment, for example, your DTI ratio is 40% ($ 2,400 is 40% of $ 6,000). Conventional loans generally require a DTI ratio about 43% or less.
- Discount points: These are fees that you can choose to pay the lender to lower the interest rate (and therefore your monthly payment). Mortgage points typically cost 1% of the home’s value. So, for example, you would pay $ 2,000 to buy a “point” on a $ 200,000 mortgage. One point can often equal a 0.25% rate cut, although the exact discount on your interest rate depends on the lender.
Where to get a mortgage
You can get a home loan from a bank, credit union, or online lender. Credible’s online loan market can help you determine how much you can borrow, get pre-approved, and compare lenders. You can compare the prequalified rates of all our partner lenders in the table below in just a few minutes.
Check the loan terms of each lender side by side and select the loan that best suits your financial situation. Typically, a large down payment, a high credit rating, a longer loan term, and a Mortgage APR can help make your mortgage payments affordable.
Advice: Keep in mind that if you go for a longer loan term, you pay more interest over the life of the loan.
To find: How to choose a mortgage: tips for getting the best loan
How to get a mortgage
The time to buy a home can stretch over several months. But there are a few basic steps to follow.
Here are the main steps of the process:
- Review your credit report. You could qualify for a conventional mortgage with a credit score of around 620 or higher, and government insured loans have more flexible requirements. But if your score is low, try to improve your credit score before applying. This could help you get a lower mortgage rate.
- Get pre-approved. Ask a lender for a mortgage pre-approval. This letter tells you how much you can borrow based on your credit, income, and other factors. Pre-approval can help you estimate your home budget and make a solid offer for a home. You will need a recent tax return, pay stubs, W-2s, and bank statements for the pre-approval process.
- Shop around for mortgage rates. Even a slightly lower mortgage rate can save you a lot of money over the life of the loan, so it’s important to compare multiple lenders. Credible allows you to do this by filling out just one form.
- Negotiate the purchase of the house and complete the application. A real estate agent can help you home buying process, such as scheduling house visits and negotiating the purchase. Once you’ve signed a buy and sell agreement and have chosen a lender, complete and submit the mortgage application.
- Get approved and close your mortgage. Your lender will review all of your information to make sure you can afford the loan. They will check your income, review your debts, and withdraw your credit. They will also confirm the home’s value through an appraisal.
Keep reading: How to get a mortgage
After the lender approves your mortgage, you will sign documents promising to repay the loan. From now on, the best thing you can do for your mortgage is to focus on making one-time payments each month.
Credible makes it quick and easy to compare multiple lenders, providing real prequalified rates within minutes without affecting your credit score.
How much will a mortgage cost?
What you will pay each month for your mortgage depends on a number of factors, but you can get a good estimate based on the interest rate and the amount of the loan.
Use our mortgage payment calculator below and enter your loan information to determine what you’ll pay monthly and over the term of the mortgage.
Enter your loan information to calculate how much you could pay
Total payment
$
Total interest
$
Monthly payment
$
With a
$
mortgage, you will pay
$
monthly and a total of
$
interest over the life of your loan. You will pay a total of
$
over the term of the mortgage.
1National Association of Real Estate Agents
About the Author
