What Is a Mortgage? Home Loan Basics for Beginners
, Mar 7, 2022
Most homebuyers do not have enough cash on hand to buy a house. If you want to purchase a home, you usually need to obtain a loan, otherwise known as a mortgage.
Mortgages put homeownership within reach for just about everyone with a steady income and decent credit score. Manageable monthly payments allow you to pay down the debt while building equity in your property. Ideally, when the time comes to sell the home, you’ll have enough equity to pay off the mortgage and have some remaining to put toward your new house.
If you are a buyer, it can be helpful to look for an experienced real estate agent. These professionals can search for homes based on your desired monthly mortgage payment and other financial factors while also finding a property with the features and design you want.
There are some nuances to mortgages that you need to understand if you are considering buying a home.
Mortgage Definition
A mortgage is a loan you take out to buy a house. It is an agreement between you and a lender where the lender agrees to pay for the home as long as you pay them back over time including interest.
Mortgages payments typically last from 15 to 30 years, or until you sell the home and pay off the balance. Even if you can purchase a home with cash, you might still consider getting a mortgage. It can free up cash for other investments or improvements to the property.
Most people talk about mortgages in terms of purchasing residential properties, such as condos, townhomes, or single-family dwellings. However, you can also use mortgages to finance the purchase of investment properties and commercial buildings.
Loan vs. Mortgage
A mortgage is a type of loan, but a loan is not always a mortgage.
Both mortgages and standard loans are financial agreements between borrowers and lenders. The borrower always agrees to repay the principal on the loan and make additional interest payments.
Mortgages have lower interest rates than many other loan types because they are secured. The borrower assumes ownership of the property and retains it as long as they meet the requirements of the mortgage agreement. If they fail to do so, the lender can take back the home.
How Does a Mortgage Work?
There is a well-defined process to securing a mortgage:
- First, you send an application to the lender. You can apply to multiple lenders to increase your chances for approval. You typically need to include data about your income, assets, current loans, and other financial information.
- The lender will look at your application information and check your credit score. They may ask for additional documents.
- If your application is approved, the lender will offer you a pre-approval letter. This document indicates the amount you can borrow and the interest rate you will need to pay.
- You can then use the loan to purchase a home or any other real estate that you are looking to buy.
You can apply for a mortgage after you have identified a particular property you wish to buy. However, it is often better to apply for a mortgage beforehand, so you know what your budget is when you begin house hunting. Additionally, sellers may prefer to work with pre-approved buyers because they know they already have the finances to buy the property.
How To Qualify and Apply for a Mortgage
Lenders want to be highly confident that you can pay back the loan they give you. By qualifying for a mortgage, you can show them that you are capable of doing so.
To qualify and apply for a mortgage, you must:
- Fill out an application: You need to complete and submit a mortgage application form from the lender you’d like to borrow from. You will need to give a complete account of all your financial dealings and investments. Lenders will then review, or “process,” your application. They may ask you for additional information after you submit your initial application.
- Review loan estimates: After applying, you simply wait for the answer from the lenders. If you qualify, they will notify you and provide an estimate for how much you can get for your mortgage. They will also give you information about interest rates and other loan terms.
- Accept the offer: After you accept the mortgage offer, the lender will send you a legal form known as the closing disclosure. The form includes all the details and terms of the agreement. After you sign it, the lender will provide the money to purchase the home.
Types of Mortgage Loans
There are different types of mortgages. As a homebuyer, you may qualify for special loan types with advantageous terms, such as a decreased down payment or favorable interest rate.
Conventional Mortgage
Conventional mortgages are loans not insured by the federal government. These loans are available with either fixed interest rates, which do not change for the life of the loan, and adjustable interest rates, which change to match the current market rate. Down payment requirements for conventional mortgages vary, but private mortgage insurance may be required if you do not put 20% down.
FHA Loan
An FHA mortgage refers to a loan that is backed by the Federal Housing Administration. The FHA does not provide mortgages itself, but it insures mortgages from approved private lenders. With FHA mortgages, down payment requirements can be as low as 3.5%, and the insurance can help people with less-than-perfect credit scores qualify.
VA Loan
VA home loans are mortgages insured and guaranteed by the Department of Veterans Affairs. Although you’ll need to be a member of the military or a veteran to qualify, you’ll benefit from favorable terms, such as a zero-down payment requirement and a more straightforward qualification process.
USDA Loan
USDA home loans are mortgages backed by the U.S. Department of Agriculture. To help with development in rural areas, they offer advantageous terms to low and middle-income rural home buyers with 100% financing, so there are no down payment requirements.
Jumbo Mortgage
Jumbo mortgage loans are above the maximum amounts set by government insurers. These loans are conventional and offered by private lenders. Currently, the limit set by the Federal Housing Finance Agency is $647,200.
Refinancing a Mortgage Loan
Refinancing a mortgage means taking out a new mortgage to pay off an existing loan. Many homeowners choose to refinance to take advantage of lower interest rates, which can decrease monthly payments. You can also change the terms of your loan to either speed up or slow down the repayment process.
However, mortgage refinancing also has some potential drawbacks, such as paying additional fees. Think carefully before opting to refinance your mortgage, as it can have lasting impacts on your finances.
Understanding what mortgages are and how they work is a crucial first step to becoming a homeowner. This way, you have the knowledge you need to find your perfect home.
