A mortgage is a loan issued by a lender, private or public, for applicant to purchase a home. The mortgage size that homebuyers typically borrow can range between hundreds to millions of dollars. Of course, there’s no such thing as free money in America! That’s why lenders charge homebuyers and/or homeowners an interest rate on these loans so they can earn some money by assuming the risks.
Either you are planning to purchase a house for whatever reasons (primary home, vacation, or rental, etc.) or planning to utilize your home equity, odds are you will need to apply for a mortgage.
As a matter of fact, a mortgage possibly is the biggest financial obligation 95% of people have and unfortunately it is a part of a journey when chasing the American dream. Therefore, as an applicant, you shall do your research and learn as much as you possibly can before signing the closing paperwork.
You are in the right place! I’m here writing this educational article as a former Loan Processor and Loan Officer who has originated over 80 millions dollars in loan size from 2020 – 2022. Keep reading if you are in the process of shopping for a mortgage or you can email us at mortgage@chadvorealestate.com to speak to our Licensed Loan Officer and check on your eligibility.
Key Takeaways
- As First-time homebuyers, understanding your options and choosing the right mortgage product is as equally as important as purchasing the right home .
- Mortgage is more than just loan for buyers to use to purchase a home. It’s a powerful tool to build wealth if using it correctly.
- Understanding how a mortgage is originated and how to prepare to optimize the loan amount will comes in handy.
What is a mortgage?
The invention of mortgage enables millions of Americans to achieve their American dreams to be a homeowner.
A mortgage is a type of loan issued to qualified borrowers by lenders and banks to purchase their homes and pay off over time simply because most of us simply cannot pay hundreds thousands or even millions of dollars in one lump sum. For more simple terms, think of it as a car loan but instead of paying it off in 3 or 5 years, it’s much longer.
Mortgage, if used correctly, can be a powerful tool for investors to use to build wealth by leveraging as much borrowing money as possible. But that will be a discussion for another day.
Key mortgage terms to know
The most commonly used mortgage terms homebuyers use are “Down Payment” and “Interest Rate“, which is completely understandable since all lenders out there spam these words in their marketing campaigns. Secondly, it’s the “Monthly Payment” and the “Loan Amount“. However, there are much more you as homebuyers must be aware and understand before signing any paperwork before obtaining a mortgage. Keep reading as we will go from the easy to not-so-simply components that go into a mortgage.
Let’s start with the basic ones:
- Down payment: The upfront fund borrowers use to pay toward the home purchase
- Loan amount: The fund borrowers seek to borrow to cover the rest of the purchase price (Final Purchase Price minus the Down-Payment)
- Loan term: The term or the time period borrowers agree to pay back the mortgage. The typical term is 15 or 30 years
- Interest rate: The cost of borrowing money typically expressed in percentage. This is where the lender makes profit by assuming the risk of borrowers defaulting on the loan. You can compare this to Annual Percentage Rate or APR for credit card or auto loan
These basic elements of a mortgage play a major part of how a lender will determine the size of a loan you’re qualified for, how much your monthly payments will be, and what the cost/profit a lender will take on. Of course, these are not the only components of a mortgage so keep reading.
To get pre-approved for a mortgage, you can email our loan department at mortgage@chadvorealestate.com to start the conversation.
The Mortgage’s Logistics
Like mentioning above, there are many different types of mortgages out there with various loan amount and sizes. However, the most common product out there that most first-time homebuyers are familiar with is the generic 30-year fixed-rate mortgage.
Here’s how it works:
- 30-year term. Once buyers sign the closing paperwork, they have agreed to pay back the loan amount in exactly 30 years with the monthly amount being broken down into 360 monthly payments.
- Interest rate remains fixed or the same throughout the term. Yep! Once you close escrow, both lenders and you cannot change the interest rate being charged on this loan. Buyers will know exactly the amount of interest they need to pay the lenders.
- The monthly principal and interest amount combined will remain the same. To keep things simple, not only the interest rate will stay the same but the monthly amount will as well. The amount buyers pay in month 1 will be the same as month 360 unless they refinance the loans.
- Fully Amortization. I’m personally not a fan of this term but it is necessary to mention it here. When a loan is fully amortized, the loan is scheduled to be completely paid off at the end of its term. However, some buyers would request to take a look at the Amortization Schedule and notice that each month will have a different ratio between the principal and interest amount due. At the start of the loan, you’ll see a much higher interest amount due rather than the principal and vice versa. It’s set up this way so the lenders can earn as much profit from the interest quickly as possible. There will be a more comprehensive article to explain how amortization works in the future.
Besides the 30-year fixed rate mortgage, there are other common options out there including 15-year fixed mortgages and adjustable-rate mortgages (ARM). There are pros and cons associating with each so before committing to one, buyers shall discuss with a financial advisor or a loan advisor.
So… Do you have to commit to the full 30-year mortgage (or to other term)?
The answer is a simple “NO”.
As a matter of fact, most homeowners do not commit the same 30-year mortgage because they either sell the property or refinance at some point before the end of the original term. In greater details:
- Selling the property attached to the loan. If there is an outstanding balance on the loan by the time a homeowner decides to sell the property, part of the proceeds from the transaction will be allocated to pay off that balance around the closing time.
- Refinance the mortgage. Interest rate never stays the same through out the year as it fluctuates up and down. If the future interest rate is much more lower than the one borrowers lock in, they can refinance the mortgage to get a lower monthly payment.
For the sake of simplicity, I will not cover refinancing mortgage or selling strategy but I will for sure cover those topics in the future.
So… Do I own my house even when I didn’t finish paying off the mortgage?
Long story short, technically speaking you do own your house as long as you do your due diligences as a good homeowner.
Your duties include not missing your mortgage payments, keep your homeowner insurance active, paying your property taxes, and keep the house in livable condition. If you do not perform, at least for an extended amount of time, your lender reserves the right to seize and sell your property to cover the amount you owe them at that time. Same for the property tax amount, the city or the county your property locate s in also have the right to do the same.
So to answer this question, as long as you keep your promises and honor the terms you agree to when you obtain the mortgage, you will remain the primary owner of the home.
ISN’T MORTGAGE THE SAME AS TRADITIONAL LOANS?
Conceptually speaking, mortgages are quite similar to traditional loans. Borrowers receive a certain amount of money as a loan and they pay back that amount along with interest charged on top over an agreeable period of time with the lender.
However, there are key differences that mortgages have over other loans.
- Mortgages are meant for real estate and real estate only. Unless we’re talking about cash-out refinance, purchase mortgages cannot be used for any other purpose except for purchasing a house. And there’s no exception!
- Not everyone can get a mortgage. In 2008-2009 financial crisis, mortgages were accessible to almost everyone even when they did not have the ability to pay back. Therefore, underwriting requirements have become stricter and much more complicated to ensure only qualified borrowers can get mortgages to avoid another financial/credit crash, which will eventually lead to a housing market crash. We will go over the requirements in the later segments. These requirements are set to protect both parties, the lenders and the borrowers.
- The fund never reaches your bank account. As a borrower and a homebuyer, the lender will facilitate the allocation of fund by paying the seller directly so you as a borrower does not interact with the fund at any given time. This practice is used to protect misuse of the fund.
- The subject property will become the collateral. Mortgage is considered a “secured loan”, which means if by any chance borrowers default on the loan, the lenders reserve the right to seize the properties and sell them to recoup their money.
Yes, some of these differences may sound intimidating but trust the process, it’s for the best!
The Advantages of Getting a Mortgage
Mortgages allow homebuyers to purchase their homes without paying a huge lump sump of cash. That’s why experienced investors love this concept since they can leverage borrowed loans and use their own funds for other types of investment.
In a sense, to homebuyers, mortgages are quite simple to understand and operate. For example, a purchase of a $350,000 home is being done through a $50,000 down payment and $300,000 loan amount. Besides the one-time payment of closing cost and a fixed interest rate of 3.5% over the terms of 30 years, all the borrowers really need to pay is approximately $1,300 monthly on their principal and interest without complicating things. Obviously, this is just a simple example for education purpose and monthly payment will vary based on the loan size along with the interest rate borrowers are qualified for.
Another beautiful thing about the concept of mortgage is its flexibility. Depending on the long-term/short-term plans of borrowers and their personal needs, some may choose 15 or 30 years terms, 50% or as low as 3% down payment, and even receive lender’s credits instead of paying high closing cost. If you have a financial goal in mind, choosing a right mortgage product will get you there faster.
The Downside of Mortgage (sort of)
Pretty simple and obvious, the total amount of interest borrowers paying back to lenders are not little. It may not seem much at first but since it’s typically over the course of 15 or 30 years, it really adds up.
However, like mentioning above, not everyone has a lump sump of cash lying around so a mortgage still acts as a great alternative option for borrowers to complete the purchase. Without the invention of mortgage, many people will never achieve the American Dream.
Types of Mortgage Product
When applying for a mortgage, it’s important to know how many mortgage products are out there and which one is the best for you. Each product yields different benefits and risks. In this section, I will mention the 3 main products that are commonly known among the readers.
- Conventional Loans: This is the most offered products by pretty much every single lender out there due to its flexible terms and straight-to-the-point qualifying requirements, which typically are good credit score, qualifying income, and moderate down payments
- FHA Loans: short for Federal Housing Administration. This product is backed by the government and designed for borrowers with poor credit score and lower income. However, home buyers with good credit score can also apply for this product.
- VA Loans: which is commonly used and only available to our qualified veterans and servicing members. This loan is backed by the Department of Veterans Affairs and is popular due to its zero-down requirement.
There are also other mortgage products with extra layers of complexities such as Adjustable Rate Mortgage, USDA, etc. If you are interested to learn more about those products, you can email our mortgage department at mortgage@chadvorealestate.com. Please keep in mind this is a high-level overview article on the process and a separated article on the different mortgage types will be published in the near future.
So what do I need to get qualified for a mortgage?
Just like most types of loan out there, in order to get the funds, borrowers must meet the minimum qualifications set out for them. Depending on the type of loans, requirements may vary but here are a few common items:
- Credit Score
- Debt-To-Income (DTI) ratio
- Loan to Value (LTV) ratio / Down Payment
- Closing Costs
Tips: During the loan originating process, borrowers may run into a few hiccups with one of these requirements and potentially have the loan denied by the Underwriter. Always make sure to ask the Loan Officers what the challenges are and if there is a way to solve the problems and move forward. Underwriters and Loan Officers are humans after all and they may not see your situation in the bigger pictures.
Credit Score Requirement
Yes, lenders use your credit scores to determine not only the rates home buyers are qualified for but even if they can qualify for a mortgage or not.
Here is the required minimum score for each program mentioned above:
- Conventional loan: 620
- FHA loan: 580
- VA loan: 580-620
Your credit report contains a lot more information than you think. Sometimes, they may list an old debt that you may not aware of or errors, which may affect your qualifications. Just make sure you always have documentations that can help you and the Loan team resolve those issues.
And no, the credit score provided to you by your credit card company isn’t always the final score lenders use. The reports are usually ordered from credit bureaus.
Debt-to-Income Ratio Requirement (DTI)
Now that lenders know your credit score, they need to verify borrowers’ income, debts, and assets to make sure you can pay them back by calculating your Debt-to-Income ratio.
How do they calculate it? It varies by different employment situations and what goes on beyond credit card statements or even credit report, which lists almost all of the borrowers’ debts. If I list everything out in this article, readers will go insane.
However, the general rule of thumb for lenders is to see borrowers to be steadily employed for the minimum of 2 years or 24 months, which borrowers will need to provide their pay stubs, W2 statements, Federal Income Tax Returns, and other relevant documents.
The lower the DTI the better the qualification will be. Each lender may have different underwriting requirements but the standard DTI ratio recommended by the Consumer Financial Protection Bureau (CFPA) is 43%.
Still confused? Let’s do a quick example:
- Total Monthly Gross Income: $10,000
- Total Monthly Debt – $4,000
- Debt-To-Income ratio: $4,000 / $10,000 = 40%
Note: Lenders always use the Gross or Pre-tax Income for the calculation. And for your monthly debt, they will use the minimum amount due by each cycle, which you can find out through your credit card statement if you have any outstanding balance.
Loan-to-Value ratio (LTV) / Down-Payment
Down payment can simply be understood as the money home buyers bring to closings and not borrowered from lenders.
Most home buyers out there usually think they will need at least 20% down in order to buy a home. However, that’s not entirely true especially if they are first time home buyers. They can put down as little as 3% to 5% if they are qualified for the program. Here’s the minimum amount for each program:
- Conventional loan: 3% down payment required
- FHA loan: 3.5% down payment required
- VA loan: 0% down payment required
Crazy concept right? 3% and you can buy a house? Unfortunately it only exists in a perfect world, where everyone’s income is equally high and credit score is in the 800s. This is when the Loan-to-Value ratio and Debt-to-Income come in.
The lesser the down payment, the larger the Loan-to-Value ratio and the larger the monthly payment are. For example, if home buyers bring 5% down-payment to closing, their Loan-to-Value ratio will be 95% (100% of the purchase price – 5% down-payment), which some lenders may charge higher interest rate and closing costs due to a higher risk loan. Additionally, with bigger loan sizes, home buyers can also expect higher monthly payments, which their gross incomes need to be high enough to qualify for.
Sound complicated? That’s why everyone should talk to a Loan Officer to discuss these details. But at least now you have some talking points after reading these articles.
Closing Costs
I personally think most home buyers overlook this portion of the loan and typically do not prepare enough funds for it. Well, I am here to break it to you. The Down Payment isn’t the only upfront expense.
Closing costs consist a few transactional charges from lenders as it costs them money to originate the loans. As a matter of fact, these items can cost up to 5% of the loan size, depending the home borrowers’ cases and loan products. So before thinking of going out there and closing on a home, I highly advise to save additional funds aside for closing cost on top of your down payment.
Want to find out if you’re qualified for a mortgage?
Getting pre-qualified and getting the actual approval from the lender are two completely different things.
Getting pre-qualified or pre-approved by the lender isn’t necessarily guaranteeing that you’ll get the loan but it’s the most common way for them to go over your personal and financial background on the very surface and provide you with a rough estimate of your loan size. As long as all pieces of information you provided to your Loan Officer is as accurate as possible, the final approval should not be an issue.
This step, like I mentioned in my First-time Homebuyer Guidelines article, is indeed the most important step in the purchase journey because it’ll help you build such a strong case for your offering package. And guess what? It’s FREE of charge so make sure you get it done first. If you need help or recommendation, you can reach out to us by sending an email to mortgage@chadvorealestate.com
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