Friday, 5 April 2019

If you want to buy a home, chances are you're going to need a mortgage.

The vast majority of homebuyers do because very few people have enough cash to buy a house outright. So, you borrow the money to purchase your home, typically from a bank or other lender, and pay it back over time.

Sounds simple, but before you start shopping for a home, it's important to have a good understanding of what a mortgage is and how it works. Here are answers to some frequently asked questions about mortgages.

What is a mortgage?

A mortgage is a loan you take out to purchase a home. In the most basic terms, you borrow money from a bank or lender, they charge you interest, and you make monthly payments until you have repaid the full amount of the loan plus interest. The time frame for paying back the loan can range from five to 30 years.

Are there different kinds of mortgages?

Yes, there are actually many different kinds of mortgages, but two of the most common mortgages are fixed-rate and adjustable.

With a fixed-rate mortgage, the interest rate on your mortgage remains the same for the entire term of your loan, which is typically 15 to 30 years. This means you'll have the same payment each month and you'll know up front — the day you sign the papers — exactly how much you will pay over the term of the loan.

With an adjustable-rate mortgage, also called an ARM, the interest rate is fixed for a certain period of time at the beginning. After that, your rate can change. ARM rates are typically tied to a major index plus a margin, such as the one-year Treasury bill. And after your initial fixed-rate period, your rate will adjust to reflect changes in that index. If the index rate goes up, your rate and monthly payment will increase. If the index rate goes down, so will your rate and monthly payment.

What are the benefits of each type of mortgage?

With a fixed rate, the main benefit is knowing exactly what your payment will be each month and exactly how long you'll be making payments. Nothing changes with your principal and interest payment, even if the term is 30 years.

There's obviously more uncertainty with an ARM, but there are some positives, too.

Depending on the specific loan, it's not unusual for the interest rate during the fixed period — let's say five years – to be lower than the rate on a fixed-rate loan. So, if you plan to be in the home for less than five years, you'll get a lower rate and lower payment than with a fixed-rate mortgage. But at the end of the ARM loan's initial fixed-rate period, the interest rate and monthly principal and interest payment could go up. If that happens, you will need to be prepared to make bigger payments if you remain in your home.

First-time homebuyers often use ARMs as they can get a more affordable monthly payment as they embark on home ownership. This also works because many first-time buyers don't stay in their first home for an extended period of time.

Another potential benefit of an ARM is that you could find yourself with a lower monthly payment if rates go down after the initial fixed-rate period.

How do I decide which type of mortgage is right for me?

There are many factors to consider, but in general, if you plan to stay in your home for more than seven to 10 years, a fixed-rate mortgage is probably a good choice.

However, if you're a first-time home buyer and anticipate moving in a few years, an ARM could provide a more affordable way for you to get into your first home. Even if you're not a first-time buyer, if you don't plan to stay in your home long, an ARM could make sense.

Do I borrow the full amount of the home's purchase price?

Ideally, you would make a 20 percent down payment on the house and get a mortgage for the rest. Which means if you're going to buy a $200,000 house, you'd need a $40,000 down payment.

However, due to the cost of housing going up steadily over the years, now it's not uncommon for banks and lenders to loan qualified borrowers as much as 90 percent — and in some cases more — of the purchase price of a home.

That being said, having a substantial down payment can make you more attractive to the bank or lender and improve your chances of approval. Whereas with a 95 percent loan, you're going to have to have some pretty stellar credit credentials in order to get approved.

How can I increase my chances of getting approved for a mortgage?

Having a good credit score is key to getting a mortgage. That's not to say you cannot buy a home with not-so-perfect credit, but a good score goes a long way when it comes to getting your mortgage application approved.

Having a good down payment can tip the scales in your favor. Your employment history also plays a role, and in most cases, the longer you've been at a job, the better you'll look.

How much debt you have is also important. Too much credit card or unsecured debt can raise concern about your ability to make all your monthly credit card payments and a house payment on top of that. Paying down your debt as much as you can before applying for a mortgage is definitely a smart idea.

Can I still buy a house without perfect credit?

Yes, you can. However, you may not get the lowest possible interest rate. It's pretty much an industry rule of thumb that the higher the credit score, the lower the interest rate. So if you don't have perfect credit, be prepared to pay a bit more for your mortgage.

Also, having minimal debt and 20 percent to put down on the house can help your odds of being approved even if you don't have a perfect credit report.

How do I know how much I can borrow?

Before you start house hunting, talk to your bank or lender and see if you can get pre-qualified, which will give you a better idea of how much you are able to borrow. Being pre-qualified is not the same as being pre-approved, which means you've already applied and been approved up to a certain amount. Getting pre-qualified will help you determine how much house you can afford.

Getting pre-approved can be helpful if you're shopping in a tight housing market, as buyers can be more inclined to sell to someone they know has already been approved for a mortgage.

What about closing costs?

With very few exceptions, you will pay some fees and other charges in order to get your mortgage. Many of these are administrative fees, and they are commonly a certain percentage of the purchase price of the home. So, the more expensive the home, the higher the closing costs in most cases.

Often these costs are factored into the mortgage, and sometimes buyers will agree to pay a portion of the fees. However, in addition to your down payment, you should be prepared to pay a couple thousand dollars in closing costs.

How do I apply for a mortgage?

Many banks and lenders have an application on their website. Completing this would be the first step. If you don't want to do it online, you can also go into a branch and start an application. Once you have filled out the online or in-branch application, a representative will contact you and walk you through the remainder of the process.

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