Mortgages 101—What Home Buyers Need to Know

If you are considering a home purchase, you are likely looking at taking out a mortgage. For many, purchasing a home is the biggest financial commitment you’ll ever make. With so much on the line, it’s essential to get familiar with the ins and outs of the home loan process.

Luckily, you are in the right place to learn about the financial strings that come attached to a mortgage. We will explore everything you need to know about getting a mortgage below.

What You Need to Know About a Mortgage

Buying a home is an exciting prospect. While it’s a big milestone in the life you are building, buying a home is often somewhat daunting. After all, this is a major financial commitment you are making.

A mortgage is a loan obtained from a financial institution, typically a bank or a mortgage lender, to finance the purchase of a home. It’s crucial to know that mortgages come in various types, such as fixed-rate mortgages and adjustable-rate mortgages, each with its own terms and conditions.

Fixed-rate mortgages offer a stable interest rate over the life of the loan, providing predictability in monthly payments, while adjustable-rate mortgages can have fluctuating interest rates that may offer lower initial payments but carry more uncertainty.

Most mortgage lenders require a down payment, which is an initial sum paid upfront as a percentage of the home’s purchase price. Interest is charged on the principal, which is the remaining balance. The loan term, often 15, 20, or 30 years, determines the duration of the mortgage.

Throughout the closing process, you’ll face many different costs, which add up to closing costs. Closing costs can involve thousands of dollars that you must pay to finalize your home purchase. It’s important to keep these costs in mind as you move forward.

When Should You Learn About & Get Ready for a Mortgage

If the idea of homeownership appeals to you, then it’s a good idea to start learning about mortgages as soon as possible. Even if you aren’t prepared to buy a home immediately, understanding the nuts and bolts of a mortgage can help you prepare for a future home loan.

Thoughtful preparation on your journey to homeownership can set you up for success. For example, working on your credit scores or saving for a down payment can pave the way for an easier closing when you are ready to move forward with a home purchase.

When Buying Becomes a Better Option for You Than Renting

It’s natural to rent a place before you buy a house. In some cases, renting is the more financially efficient option. That’s especially true if you don’t have strong ties to a location. If you might move in the next couple of years, renting affords you more flexibility.

However, there are times when buying becomes a better option than renting. When you have a steady income and can afford the monthly mortgage payments, homeownership can be a smart choice. While renting offers no equity buildup, paying a mortgage allows you to build wealth through home equity, which can gain value over time.

You’ll need to decide when buying becomes the right move for your financial situation.

7 Tips to Get Ready for a Mortgage

If you are considering buying a home, it’s helpful to prepare your financial situation in advance. Below are some ways to start getting ready for a home purchase:

• Check your credit scores: Begin by reviewing your credit reports and scores. Higher credit scores can lead to better mortgage terms and lower interest rates.
• Reduce debt: Minimize outstanding debts, as high debt-to-income ratios can hinder your mortgage eligibility. If possible, pay off credit cards and loans.
• Save for a down payment: Start saving for a down payment. Even though you might not be required to make a 20% down payment, you’ll likely need to put down several thousand dollars.
• Establish a budget: Create a realistic budget that includes potential mortgage payments, property taxes, insurance premiums, HOA fees, and maintenance costs. This will help you determine what you can comfortably afford.
• Shop for lenders: Compare mortgage lenders to find the best rates and terms.
• Get pre-approved: Obtain a mortgage pre-approval from a lender. This not only helps you understand your budget but also makes you a more attractive buyer to sellers.
• Gather documentation: Be prepared to provide financial documentation, such as tax returns, pay stubs, bank statements, and employment history, when applying for a mortgage. Having these ready can streamline the process.

Also, take some time to evaluate your future plans. If you aren’t strongly committed to living in an area for at least five years, it might not be the right time to purchase a home.

The Essential Types of Mortgage Loans

As a home buyer, you have several different mortgage loan options to choose from. Below is a closer look at some of the different types of mortgage loans you may be able to pursue:

• FHA loan: Insured by the Federal Housing Administration, this loan option is accessible to borrowers with lower credit scores and allows for down payments as low as 3.5%.
• VA loan: Available to eligible veterans and active-duty service members, this loan offers competitive terms and often requires no down payment.
• USDA loan: Designed for rural homebuyers, this loan provides low to no down payment options and is guaranteed by the U.S. Department of Agriculture.
• Conventional loan: Not backed by a government agency, this mortgage is offered by private lenders and typically requires good credit and a down payment, though it can be flexible.

Additionally, mortgages are available through fixed-rate and adjustable-rate options.

What Mortgage Rates Are & How They Work

Mortgage rates are a critical component of the home-buying process and can significantly impact the cost of homeownership. Simply put, a mortgage rate is the interest rate charged by a lender on the money borrowed to purchase a home. These rates fluctuate over time, influenced by various economic factors. 

Mortgage rates are determined by the broader financial market and are heavily influenced by economic indicators, investor sentiment, and the actions of the Federal Reserve. When the economy is strong, the Federal Reserve may raise interest rates to control inflation, which tends to lead to higher mortgage rates. Conversely, during economic downturns, the Federal Reserve may lower rates to stimulate borrowing and spending, which can result in lower mortgage rates. When determining the interest rate for an individual borrower, lenders also consider the borrower’s credit scores, the loan-to-value ratio, and the specific type of mortgage product.

As a home buyer, the mortgage rate you lock in can have a big impact on your home purchase budget. Higher interest rates add to your monthly payments, which means you’ll likely have a smaller purchase price budget. But if interest rates are relatively low, you might have more room in your budget to purchase a home with a higher price.

Credit Score to Buy a House

Lenders use your credit scores to assess your creditworthiness and determine the terms you’ll be offered. The most commonly used type of credit score in mortgage lending is FICO scores, which typically range from 300 to 850.

Here’s a breakdown of credit score ratings, according to Experian:

• Poor (300-579): You may have difficulty obtaining a mortgage, and if you do get one, it will likely come with high interest rates and strict terms.
• Fair (580-669): You may qualify for some loans, but rates may be less favorable, and you might face limitations.
• Good (670-739): With good credit scores, you’re more likely to qualify for a mortgage with competitive interest rates and terms.
• Very Good (740-799): This credit score range makes you an attractive borrower, and you’ll typically have access to lower interest rates.
• Excellent (800-850): Lenders view you as a low-risk borrower, so they can offer you the best terms and interest rates available.

Lenders often have minimum credit score requirements. Usually, the minimum credit score is around 620. While it’s possible to get a mortgage with lower scores, it can be challenging and may result in higher costs. Strong credit scores not only increase your chances of loan approval but also enable you to secure more favorable loan terms.

Understanding & Finding Mortgage Assistance Programs

Many states and local governments offer mortgage assistance programs for first-time home buyers. If you are a first-time buyer, which usually means you haven’t owned a home in at least three years, you could tap into a variety of assistance options.

For example, you might find down payment assistance programs willing to help cover your down payment costs. Or you might find a program designed to help you pay for closing costs. If you qualify, mortgage assistance programs can help you purchase a home.

Plan for the Full Mortgage Term

Homeownership is a long-term financial commitment. With a long-term outlook, it’s important to plan for the future as you sign up for this major loan.

It’s essential to establish a budget that considers not only the initial down payment and monthly mortgage payments but also other ongoing expenses associated with homeownership. These costs can include property taxes, homeowner’s insurance, maintenance and repairs, and possibly private mortgage insurance (PMI) if you didn’t make a substantial down payment. Creating a comprehensive budget can help you avoid financial strain and ensure you can comfortably meet all your financial obligations.

Another critical aspect of planning for the full mortgage term is building a financial safety net. Life is full of unexpected twists and turns, and having an emergency fund is essential to cover unexpected expenses like medical bills, car repairs, or home-related emergencies. It can also serve as a buffer if you face financial difficulties, such as job loss, during the course of your mortgage. An emergency fund can help you continue making your mortgage payments on time and prevent the risk of foreclosure.

Some homeowners may choose to pay off their home loans ahead of schedule. If early repayment is a part of your plan, set up a plan to make it happen. For example, you might decide to pay an extra $100 per month towards your mortgage. That decision could help you shave thousands of dollars in interest charges and years of payments off of your mortgage loan.

Key Mortgage Takeaways

Taking on a mortgage is a big decision. If your finances are in a stable position, moving forward with homeownership might be the right move for your financial future. But it’s important to wait on making this big purchase until you are financially stable. Otherwise, taking on the pressure that comes with a large loan could put more of a strain on your finances.

As you delve into homeownership, do your research and get comfortable with your numbers before making an offer on a home.

Mortgage FAQs

What Is the 33% Rule When Buying a House?

In general, lenders require borrowers to take on a housing payment that’s less than 33% of your monthly gross income. But this number could change if you have other significant debt burdens.

Do You Have to Put 20% Down on a House Purchase?

No. Most lenders don’t require borrowers to make a 20% down payment. While you can make a smaller down payment, that means you’ll take on a larger loan amount.