MORTGAGE
101

Buying a home loan doesn’t have to be intimidating – especially when you understand the basics.

Fixed vs. Adjustable

Every home loan has two parts: principal and interest. The principal is the amount you borrow, and the interest is what you pay to borrow the money. Different home loans give you options on how to structure your interest payments to meet your specific needs.

When shopping for a home loan, there are two major types of loans that you can choose from: a fixed-rate mortgage or an adjustable-rate mortgage (ARM).

With a fixed rate mortgage, your principal and interest payments stay the same for the life of the loan—a good choice if you’re planning to stay in your home for a long time. Because the interest rate doesn’t change, you’re protected from rising rates for the life of your loan.

The main features of a fixed-rate mortgage are:

• Principal and interest payments stay the same for the life of the loan
• Consistent monthly payments allow you to budget more effectively
• Choose from varying year terms, such as 30 year or 15 year

With an adjustable rate mortgage (ARM), also called a variable rate mortgage, your Interest rate, monthly principal, and interest payments remain the same for an initial period, then adjust annually based on a rate index.

The main features of an ARM are:

• Typically have a lower initial interest rate than a fixed-rate mortgage
• Interest rate caps set a limit on how high your interest rate can go
• Choose from 6-month, 1-, 2-, 3-, 5-, and 7-year terms

If you are considering an ARM, it is a good idea to ask your mortgage lender what your monthly payment would be if interest rates rise 1, 3 or 5 percentage points in the future, so you can get a sense for how much more you may be required to pay in the future.

Government loan programs offered by the Federal Housing Authority (FHA) are also popular and are available in both fixed-rate and adjustable-rate structures. In general, government loan programs are easier to qualify for and have lower down payment requirements as well as more flexible credit requirements. However, like conventional loan programs, FHA loans have specific fees and payments associated with each of them.

Getting Prequalified

Before you start looking for a home, you will need to know how much you can afford, and the best way to do that is to get prequalified for your loan. Many real estate agents want you to be prequalified so they can show you homes in your price range.

To get prequalified, click here. You can also use our Home Affordability Calculator to see the price range of homes you should be looking at.

Terms

The term is the number of years that you will make payments on your home mortgage loan. The longer the term, the lower your monthly payment will be. With a longer term, you will also pay more in interest over the life of the loan.

Use our Mortgage Payment Calculator to see how different terms can affect your monthly payment.

Interest Rates

The interest rate is the proportion of a loan that is charged as interest to the borrower, typically expressed as an annual percentage of the loan outstanding. It is used to calculate your monthly mortgage payment. The higher the interest rate on a particular loan, the higher your monthly payment will be, and vice versa. With a fixed-rate mortgage, the interest rate on your loan will never change. With an ARM, however, the interest rate is linked to an index of interest rates published by a third-party, such as the federal government. As this index changes over time, so will the interest rate used to calculate your monthly mortgage payment.

APR

The annual percentage rate or APR tells you the estimated cost of your loan, which includes the interest rate and other upfront fees that you pay for the loan (such as discount points and origination fees). Comparing APRs will help you understand which loan is actually the best value for you when all costs are considered.

Closing Costs

Buying a home or refinancing a mortgage requires the help of a lot of different people (the lender for processing the loan, the title company for verifying ownership of the property, the appraiser for assessing the value of the home, etc.). All of the fees from these services are collectively called closing costs. These fees commonly total about 2-3% of the loan amount, but they can be higher.

Some of these costs are controlled by the lender, while the rest are controlled by other firms that are involved in your loan process. The closing costs can either be paid up-front, or in some situations, the lender will add them to the amount you are borrowing. Your lender will outline these costs in a Loan Estimate, so you can get a sense for how much you will need to pay when the loan closes. Your mortgage loan officer will send you the estimate within 3 business days of processing your application and help you to understand what you are paying for.

Monthly Mortgage Payment

Generally, your monthly mortgage payment includes principal and interest. Property taxes and homeowner’s insurance may also be collected by the lender through your monthly mortgage payment, held in an escrow account, and then paid on your behalf when the payments are due. Escrow literally means the holding of documents and money by a neutral third party.

Your property taxes and homeowner’s insurance may be reassessed each year during an annual escrow reassessment period. Your mortgage servicer will recalculate what your new monthly payments will be and let you know how much you owe. These payments will be put into escrow and paid on your behalf.