Buying a home is likely the largest purchase you will ever make, and the mortgage needed to pay for this purchase is probably the biggest amount of debt you'll ever take on.
Mortgages come in all different types, and can often confuse the average buyer. Since you’ll likely be stuck with your mortgage for many years, it helps to understand the ins and outs of this crucial financial tool.
- What is a Mortgage?
A mortgage is a loan that a lender extends to a home buyer to help finance the purchase of a property. The monthly mortgage payments are made up of:
- Principal - the amount that goes towards the equity;
- Interest - the rate you are charged to obtain the loan;
- Insurance - if your down payment is less than 20% of the purchase price;
- Taxes - calculated based on the property’s value.
The purchased house acts as collateral in exchange for the borrowed funds.
- What types of mortgage are there?
There are various options out there in the world of mortgages:
Fixed-rate mortgages - The interest rate on a fixed-rate mortgage remains constant throughout the term of your loan, which means your payments will always be the same. You lock into a specific interest rate, which will not change until the term is up. The amount you pay towards interest will be large at first, but will gradually decrease as you make payments. This option is generally favorable if the current rates are low.
Adjustable-rate mortgages - The interest rate on an adjustable-rate mortgage will fluctuate, which means the interest portion paid on your monthly payments will change.
Government-insured loans - These loans are insured by the government, and typically include FHA loans and VA loans.
Conventional loans - These mortgages are not guaranteed by the federal government.
- Will I lose my house if I don't pay?
It is possible to lose your home if you continue to fail to make your regular monthly mortgage payments. Even just one missed payment technically means you are in default. If this happens, the lender typically will allow a 15-day grace period to allow you to make up for the missed payment(s).
Once the lender chooses to note the mortgage as being in default, a Notice of Default will be filed with the county recorder. If the lender does not get a response from you, and still doesn't receive the missed payment, the foreclosure process can begin as early as three months after the first missed payment. A lawsuit is filed, and notice is given about the lender’s intent to sell the home. After about six months following the first missed payment, the lender can sell the home and notify you of your obligation to vacate the property.
- Can I make larger payments than the bank demands?
This will depend on the terms of your mortgage with your lender. Typically, lenders will allow extra payments to be made to shorten the life of the mortgage. There are also options to put down a lump sum once a year to put towards the principal of the mortgage, though the limit of this amount will depend on the lender and your specific mortgage contract. Some lenders charge a penalty fee for early mortgage repayment, so it’s important to check first before making a larger payment.
- Is it better to pay a mortgage faster?
Usually, the answer to this question is yes. The faster you pay off your mortgage, the less interest you will have paid at the end of the mortgage term. Paying a mortgage off faster can translate into tens of thousands of dollars saved, depending on the interest rate and the loan amount. For instance, a $200,000 mortgage at 3.5% paid over 30 years will cost $123,312 in interest over the life of the mortgage. Shaving 10 years off the mortgage lifespan will cost $78,381 in interest, a savings of $44.925.
However, many homeowners choose to hold onto their mortgages if they have a low-interest rate, and put their money towards higher-interest investments. If, for example, money is placed in an investment that pays out 7% per year, it might make sense to keep the mortgage ongoing while using capital to earn more money on higher-interest investments.
- How much interest will I pay?
The interest you’ll be charged will depend on a number of factors, starting with the current rate being offered by the lending industry. As of this writing, the interest rate for 30-year fixed-rate mortgages is 3.62%. However, your credit score and financial history will play a key role in what your lender charges you on your mortgage.
Borrowers with a high credit score and solid financial positions will typically be offered the lowest rate. But those with poor scores and volatile financial histories will often be charged much more. This is because lenders will want to protect themselves against the higher risk of mortgage default.
- Can I have more than one mortgage?
Yes, but the number of mortgages that you take out will depend on the loan program. It’s not against the law to have too many mortgages, but you’ll be paying for these services with higher interest rates and fees. Many Americans take out additional mortgages to finance other properties, such as vacation homes or investment properties.
- Can I have more than one mortgage on the same house?
Yes. Many Americans take out second mortgages in order to free up equity in their homes to be put towards large purchases, such as university tuitions or major home renovations. They might also take out additional mortgages to consolidate debt, or cover part of the down payment on the first mortgage in order to avoid property mortgage insurance (PMI) requirements.
- How many years will I be paying a mortgage for?
This will depend on the term of the mortgage that you agree to. The average mortgage term is about 25 years; however, it can typically range anywhere between 10 to 30 years. The shorter the term, the higher the monthly payments will be.
However, shorter terms also mean much less money goes towards the interest portion of the loan, which can translate into significant savings. Of course, the term you opt for will depend on how comfortable you’ll be at making mortgage payments. If you can realistically only afford a smaller amount, then a longer term may be best.
- Do banks vary in their mortgage offers?
Yes, which is why it’s wise to shop around from one lender to the next. There are hundreds of different banks and lenders that compete with each other to offer eligible borrowers the lowest rate and best terms. May of the mortgage packages offered by various lenders are entirely unique. What may suit one borrower may not necessarily suit another. Of course, your credit health and financials will play a role in what various lenders will offer you.
- If I have a bad credit score can I still get a mortgage?
That depends on how low your score is. Typically, anyone with a score under 520 will likely be denied a conventional mortgage. However, there may be private lenders out there willing to extend a loan for those with a lower score, although the interest rate charged will be very high.
Generally speaking, the lower your credit score, the higher interest you’ll be charged, if you get approved. Lenders need to protect themselves in the event of a mortgage default. They typically see borrowers with a low credit score as being less likely to be capable of making payments in full and on time, which is why a higher rate is typically tacked onto riskier mortgages.
- Will a bank lend me 100% of the purchase price?
Yes, depending on your credit score and financial history. With 100% home financing loans, there’s no need to put a down payment towards the purchase. New and repeat buyers may be eligible for 100% financing through various government-sponsored programs.