In order to get a mortgage, you put up your property as collateral against the loan you receive. That means that if you fail to meet the payment schedule of your loan, you could lose your property to the lender. Since you risk losing something for not making payments, this makes mortgages a “secure” loan. In contrast, credit cards are typically “unsecured.”
When you take out a mortgage, you agree to the loan for a set period of time. The most common loans for property are 15- or 30-year mortgages.
When you pay back the loan, you pay money to both the principal of the mortgage and the interest that the lender charges. The principal is the total sum of the money you borrowed, and the interest rate is a percentage of your monthly payments.
In order to get a mortgage, the lender will check your financial history, including things like credit score and any outstanding debts you have. They will also require a downpayment for the property you buy: you will never be able to get a loan for 100% of the money required to purchase a home.
As you pay back your mortgage, you build equity in your home. Initially, you will be paying a higher amount in interest than principal. As time goes on, and you start to chip away at your repayment, you will owe less in principal and therefore be paying less in interest.
Types of mortgage loans
There are numerous mortgages offered via banks or private lenders, which will all have different rates, requirements and lengths. For new homebuyers and those looking to refinance their mortgage, there's quite a few options.
Understanding how each mortgage loan type works is key to determining which one to apply for.
The most common way to finance a home, conventional mortgages are loans that are not financed by the federal government. They have stricter requirements to qualify for and will typically need a credit score of at least 620.
With a conventional mortgages, you can get either a conforming or non-conforming loan.
Conforming loans are available to a maximum amount, which is established by Freddie Mac or Fannie Mae (mortgage companies created by Congress).
Non-conforming loans, or jumbo loans, have much higher limits and typically have higher interest rates and greater down payment requirements.
If you’re looking to take out a loan that doesn’t conform to limits set by Freddie Mac or Fannie Mae then you’re looking at getting a jumbo loan.
The conforming loan limit (CLL) applies to single-family one-unit home mortgages. The CLL values for 2022 are as follows:
$726,200 in most U.S. counties.
$726,201 - $800,000 for some counties in California, Idaho, Colorado, Tennessee, and Connecticut.
$800,001 - $1,089,299 in some counties in Washington, California, Colorado, Florida, New York, New Hampshire, and Massachusetts.
$1,089,300 in some high cost areas, like counties in California, Idaho, Wyoming, Utah, Maryland, West Virginia, Virginia, Pennsylvania, New Jersey, New York, Massachusetts, and all of Alaska and Hawaii.
You will generally need a higher down payment and a credit score of 720 or better to qualify for a jumbo mortgage. As well, you will probably undergo a more rigorous underwriting process as the lender will want to know you will be able to manage the debt.
If you’re a first-time homebuyer, the Federal Housing Administration (FHA) loan might be for you. While you don’t have to be a first-time buyer to qualify, it’s more common among first-timers since they generally have lower credit scores.
To qualify for an FHA loan, you'll need at least:
A credit score of 500 or above
A debt-to-income (DTI) ratio of 50% or less
A down payment of at least 3.5% if your credit score is better than 580
A down payment of at least 10% if your credit score is between 500 and 579
If you’re thinking of moving to a rural area or a less populous region, you may qualify for a United States Department of Agriculture (USDA) loan.
These loans are backed by the Department of Agriculture, so if you fail to make payment the government will step in. This is a reassurance for the lender, which is why the loans offer lower interest rates and no down payment.
To qualify for a USDA loan, you need to:
Be a U.S. citizen or permanent resident.
Agree to make the home you purchase your primary residence.
The mortgage should account for no more than 29% of your gross monthly income.
Your total monthly debt divided by your monthly gross income should be no more than 41%.
You may require a credit score of 680 or greater if you don’t meet the above requirements.
These loans typically have higher interest rates and are for shorter terms than conventional mortgages. They generally last for around one year - the amount of time it takes to build the home.
The money of your loan will be lent to you in phases. As with any loan, you’re responsible for repaying the debt, but you usually only have to pay back the interest on the funds you’ve borrowed until the home is complete. Once the construction is completed, the lender will want to see an occupancy certificate to ensure the work is done and the space is livable.
Some of the minimum requirements for approval include:
Good to excellent credit. Generally you’ll need a credit score of 680 or better.
Stable income. Lenders want to see that you earn enough to cover your loan payments.
Low debt-to-income ratio. You want your debt to be less than 45% of your income. The lower debt-to-income ratio, the better.
A healthy down payment. The more money you have for a downpayment, the better chance of getting a loan. 20% to 30% is a good target.
The Veteran Affairs (VA) loan provides active service members, veterans, and some surviving military spouses with loans to purchase property.
These loans are guaranteed by the Department of Veterans Affairs, and require no down payment or mortgage insurance. There is a VA funding fee — basically an insurance that protects the department from costs if a borrower defaults. This fee ranges from 1.4% to 3.6% of your loan.
When it comes to home loans, you generally have two options - a fixed-rate or variable-rate (adjustable rate) mortgage. Each type of loan has its pros and cons, so if you’re deciding between the two, it’s important to know what they offer.
Fixed-rate mortgages offer you the same interest rate for the term of the loan. Your monthly payments will remain constant, but additional fees like property tax and insurance can change.
Eli Sklar, SVP of mortgage lending with Guaranteed Rate, observes that fixed rate mortgages offer “the knowledge and the assurance that the payments on the mortgage will not increase no matter what the future brings in terms of rates and economy.“
The most common terms for fixed-rate mortgages are 15- and 30-year.
Same monthly payments over the life of loan.
Easier to budget.
If interest rates fall, you’ll still be paying higher fees.
The longer the term, the more you pay in interest.
An adjustable-rate mortgage (ARM) starts out with a fixed-rate for a certain number of years. After that, the interest that you pay will adjust with the market. This means that your monthly payments will change as well.
ARMs will be expressed as a combination of two numbers, like “5/1 ARM” or “3/5 ARM”. The first number indicates how many years your initial interest rate will hold for; the second number indicates after how many years the interest rate will adjust. So for a 5/1 ARM, you will have the same interest rate for the first five years, but it will adjust every year after that term.
Lower initial monthly payments.
Can pay more to principal of loan at start.
Interest rate can rise after the initial term.
Difficult to budget for interest rate changes.
If you’re planning on selling your home in a few years, an ARM can be a good option as you will enjoy the benefit of lower interest rates.
A fixed-rate mortgage is beneficial if you want to remain in your home for a long time as you can budget around the monthly payments.
With both ARMS and fixed-rate mortgages, you have the option of refinancing your loan. This allows you to take advantage of potentially lower interest rates.
“Most people historically do not hold on to a mortgage for more than seven years,” observes Sklar. With an ARM you will not have to worry about rates escalating if the rate is locked for the seven to 10 years.
Test your mortgage knowledge
What is the average mortgage payment (as of March 2022) for a 30-year fixed mortgage?
Mortgage term lengths
When it comes to choosing a mortgage, there are a lot of factors to consider. How much of a debt load can you handle on a monthly basis? Do you want lower monthly payments or a shorter-term for your mortgage?
30-year mortgage rates — The most popular type of home loan. This mortgage is a great solution if you plan on living in your home for an extended period. While it offers low monthly payments, you will pay more in interest over the duration of the mortgage.
20-year mortgage rates — While not as common as some other forms of mortgages, 20-year terms give you a lower interest rate than a 30-year, and cheaper monthly payments than a 10- or 15-year loan. Despite offering predictable monthly payments, 20-year mortgages are more difficult to qualify for. Lenders will want to ensure you can afford the higher fees and have a low debt-to-income ratio.
15-year mortgage rates — One of the most common mortgage types, the 15-year amortization period offers lower monthly payments than a 10-year mortgage, and less money going to interest than with a longer term. You’ll probably get a smaller loan with a 15-year mortgage than a 30-year one, and therefore won’t have as much money to buy a more expensive home. Despite this, you will be building equity in your home faster.
10-year mortgage rates — If you can afford the higher monthly fees that come with a 10-year mortgage, they offer some big advantages. The shorter-term means that you’ll own your home faster, and you’ll also be paying a lot less in interest over the years. To get a 10-year mortgage, you’ll require a low debt-to-income ratio and good credit, as your monthly costs are going to be a lot higher. You’ll probably also have less purchasing power with a 10-year mortgage, unless you have the cash and can afford a substantial downpayment.
There's a lot that goes into your mortgage rate. Firstly, they can differ depending on your location. States such as New York and California are infamous for having high mortgages, while Iowa and Indiana are known for being more affordable.
The federal lending rate also impacts the overall rate that banks and other lenders are offering.
Your credit score, the amount of loan your seeking and the length of your mortgage all contribute to the rate you are offered.
A home is probably the most expensive purchase you’ll ever make. As a first time home-buyer, you might be overwhelmed by the entire process. But there’s no reason to get discouraged.
The first thing you need to consider when buying a home is how much you can afford. When you buy a home, you typically are going to have to make a downpayment, then be prepared to make monthly mortgage payments.
A common rule of thumb is not to spend more than 25% of your take-home income on monthly mortgage payments. This provides you with a nice cushion so you won’t be living beyond your means. Try using a mortgage income calculator to help give you an idea of what your budget might look like when you consider your down payment and interest on your loan.
You’ll also need to consider things like closing costs, taxes, home insurance, and maintenance when figuring out what you can afford.
When it comes to buying a home, there’s a pretty good chance you won’t be able to pay cash for the entire purchase. Instead, you’ll make a downpayment, and the rest you’ll take out in the form of a mortgage. If you make a down payment of less than 20%, you’ll also have to purchase mortgage insurance, which will be folded into your monthly payments.
Mortgages are loans that lenders give you using your home as collateral. Failure to make your monthly payments can result in you losing your home.
Getting pre-approved for a mortgage can help make the homebuying process faster. A mortgage pre-approval is a formal letter that a lender gives you, stating how much money you are able to borrow and what interest rate you’ll get.
Another advantage is that it lets you lock into an interest rate before you buy your home.
As you start your search for a home, you’re going to want to find out your credit score. This is a number between 350 and 850 that’s used to measure how you handle debt. The higher the score, the better your credit rating. In order to get a mortgage, most lenders want you to have a score of 620 or greater.
“Make sure to take care of credit scores first,” notes Sklar, “as this will impact best rates and programs in the market.”
Sklar also recommends that you save as much as possible so you have money to put down for your purchase transaction and have money on [the] side for a rainy day.
When deciding on a mortgage, you’ll also have to choose between a fixed-term or an adjustable-rate mortgage (ARM). Each offers distinct pros and cons, so you’ll want to know what each offers before signing on.
Mortgage type and length
You’ll also want to decide if you want a fixed-term or adjustable-rate mortgage (ARM). Each offers distinct pros and cons, so you’ll want to know what each offers before signing on.
You’ll also need to know how long you want your mortgage term to be — that is, how long it will take you to pay it off. The longer the term, the lower monthly payments you’ll have, but you’ll also be paying more in interest.
When figuring out what your mortgage term should be, Sklar recommends taking into account how long you intend to stay in the home for. Your term should be based on things like “growth of [your] family, change of work, and market expectations.”
Be sure to compare mortgage rates among lenders to ensure you’re getting the best possible price. Different lenders offer different rates, and a difference of a few percentage points can mean thousands of dollars.
Once you’ve figured out the details of what you can afford, find a realtor or real estate agent that understands your needs and budget. Work with them to find the best home for you, and don’t be afraid to walk away if you find your needs aren’t being met.
After you’ve found a home you like, you’ll make an offer and, if it’s accepted, begin the closing process. A good agent will be extra helpful at this stage, as they will help negotiate the best deal for you, and take care of much of the paperwork.
It helps to calculate what your total monthly principal, interest taxes, and insurance (PITI) payments will be each month. You can also calculate your maximum principal and interest (PI) to find out what the maximum mortgage payment you can afford is.
Homeownership might feel out of reach at times, especially for low- and moderate-income Americans. You may have shaky credit, or may not have enough saved to make a downpayment. The good news is that there are a number of federal programs and grants aimed to help close the financial gap.
In most instances, the home being purchased with the assistance of a government loan needs to be used as your primary residence.
Good Neighbor Next Door Program:
For public servants like teachers, firefighters, paramedics, and police officers
Must live in the home purchased and work in the area for a minimum of three years
Can purchase a home for half of the listed price
Can use any mortgage type as long as it meets the eligibility requirements
Bids must be made by a HUD registered real estate agent
Freddie Mac and Fannie Mae First-Time Homebuyer Program
Down payments as low as 3%
Generally requires a credit score of 620 or more
If your income is below the area’s median, you may qualify for special loans
HomeReady and Home Possible loans offer things like alternative paths to prove creditworthiness other than credit score and the ability to use home repair investments as part of downpayment
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Getting pre-approved for a mortgage
Getting pre-approved for a mortgage has a lot of benefits. Beyond giving you a better idea of how much home you can afford, it can make the sale of the home quicker, and give you leverage when negotiating a deal - especially if there are multiple bids.
Here’s what you’ll need to get a mortgage pre-approval.
Proof of income: You’ll probably be required to show your W-2 wage statements from the last two years, as well as pay stubs from the last 30 days. Mortgage providers want to know you have an income incoming.
If you have alternative income, like rental property income or you drive for a car sharing company on the side, you’ll want to have this proof of income as well.
Down payment: You’ll need to show that you can make the downpayment for the house, as well as having the cash to cover closing statements. For this you’ll need bank statements or a proof-of-funds letter. You may require a gift letter as well if a family member is helping you with the cash to buy the home.
Credit score: Your credit score demonstrates how much risk you pose as a borrower. The higher the score, the more likely you are to get a mortgage and the lower rate you’ll get.
You can get a copy of this from Transunion, Experian or Equifax, but be careful not to request it too many times as this can affect your score.
DTI: Your debt-to-income ratio (DTI) compares your existing debt to your income. This lets mortgage lenders know whether or not you can handle the additional debt. Generally the lower your DTI, the better the mortgage rate you’ll get.
Other: Be prepared to provide things like proof of identity, bank statements, and rent checks if you’re a renter.
What credit score do you need to get a mortgage?
When applying for a mortgage, generally you’ll require a credit score of 680 or above.
Generally, you’ll want as high of a credit score as possible. A score of above 700 is what many lenders consider average.
740-850 - Excellent — Lenders will feel very confident granting you a home loan if your credit score falls into this category.
720-739 - Very good — A 740 credit score is generally the threshold most lenders look for in order to feel comfortable with a borrower.
700-719 — Average — Many lenders will provide home loans for people with these credit scores, though those at the lower end may have trouble getting a decent mortgage rate without a hefty down payment.
680-699 — Below Average — A credit score in this range is generally the result of questionable credit decisions, and many lenders will want to stay away. But consumers with these scores may be able to get Federal Housing Administration (FHA) loans.
There are a few reasons why you may want to refinance your mortgage:
To lock into a lower interest rate
To modify your loan terms. Shorter terms generally mean less interest
To change your mortgage type from an adjustable rate to a fixed-rate or vice-versa
To access the equity you have built into your home
If you’re considering refinancing your mortgage, be sure to consider things like closing costs, potential penalties, and what the current interest rate is. You’ll want to carefully examine these additional costs to determine if refinancing is the right move for you.
When it comes to getting the lowest rate on mortgages, a lot depends on what your credit score is. The higher your score, the lower your rate. You should aim for a score of 740 or higher to get the best rate. Additionally, the more money you can put as a downpayment, the lower the cost of your loan will be.
Mortgage rates are affected by a variety of factors. When more people want to buy homes and borrow money, lenders typically charge higher interest rates. When the economy is growing slowly, interest rates tend to be lower so individuals are inspired to borrow money.
The Federal Reserve, America's central bank, helps set short-term interest rates. Mortgage rates are influenced by the same economic conditions and will often move the same way as the Fed’s benchmark rate, even though there’s no direct connection.
What is the right time to qualify for a home mortgage rate?
To qualify for the best home mortgage rate, you want to ensure that you have good credit and a low debt-to-income ratio. This demonstrates to lenders that you can manage your money well and are able to carry debt. Additionally, if you can afford a large down payment for a home purchase, it might be the right time to apply for a mortgage.
An interest-only mortgage lets you pay only the cost of your loan for a set period of time, often five to 10 years. When that term is up and it’s time to start paying the loan principal, too, the monthly payments can balloon.
Locking your mortgage rate guarantees that you’ll pay that rate for as long as the lock remains in place — regardless of what happens to rates in the marketplace during that time. Even if interest rates skyrocket, you’ll continue to pay the same amount of interest on your mortgage.
Discount points let you effectively “buy down the rate” of your loan. A point will cost you 1% of your loan’s overall value.
Each point you purchase decreases your interest rate by one-quarter of one percentage point (0.25) for the life of your loan. You can buy multiple points or even fractional points, depending on what you can afford. You’ll need to pay for them at closing, along with your other closing costs.
Be sure to compare mortgage rates among various lenders to find the best rate possible, and understand what the current interest rates are. If you have a great credit score and are able to put down a substantial downpayment, your chances of negotiating a better rate also improve.
Because banks and lenders are businesses, and they want to make a profit. Depending on factors like overhead costs and the risk they’re taking in lending money for mortgages, they may offer a higher or lower interest rate.
If you want to change your mortgage rate after locking, it is possible to refinance your mortgage. Basically, you’ll be taking out a new mortgage to pay what you left owing on your current term.
Before you refinance your mortgage, be sure to calculate what the associated costs will be. There are fees, closing costs, and possible penalties when you refinance, which may make refinancing less attractive.
Prior to joining Moneywise, James Battiston was a frequent contributor to Ratehub where he wrote extensively on mortgages, home and life insurance, and has broadened his expertise to include retirement. Additionally, he has written content for companies such as Applied Systems, Access Storage and Aphria Inc. He holds an honours BA from the University of Toronto and is a graduate of the Canadian Film Centre. He loves to spend his spare time with his family and drinking copious amounts of coffee.
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