A mortgage is a long-term loan that a homebuyer obtains from a bank, savings and loan, mortgage broker, online broker or even the property seller. The house and land on which the house sits serve as collateral for the loan. If the borrower doesn't make payments as agreed, the lender can take the home through foreclosure.
A monthly mortgage payment is sometimes called a PITI payment because it typically covers a portion of the following four costs:
- Principal (Loan Balance)
- Interest Owed on Balance
- Real Estate Taxes
- Property Insurance
In addition, some loans stipulate that the borrower must pay the cost of the mortgage insurance-a type of insurance that protects the lender if you default. This insurance will be required for Federal Housing Administration (FHA) or Veterans' Administration (VA) loans and most conventional loans with down payments of less than 20 percent. If required, several quotes from different institutions should be obtained.
Mortgage Shopping Tips
Look for a mortgage that has no prepayment penalty. That gives you the option to pay off your mortgage early if you wish. Then analyze whether a fixed-rate, adjustable rate, or interest-only mortgage is best for you.
With a fixed-rate mortgage, the interest rate on the loan stays the same for the term of the loan, which could be 15, 20 or 30 years. The advantage of a fixed-rate loan is the security of knowing that the interest rate will never change, which helps you fix your housing costs.
Adjustable Rate Mortgages (ARMs)
An adjustable rate mortgage, in contrast, has an interest rate that can vary during the life of the loan, with the possibility of both increases and decreases in interest rate. An ARM frequently offers a lower initial interest rate than a fixed-rate mortgage; however, over time, the interest rate can rise, so it's important to know what the cap, or limit, is on the interest rate and determine if you could still afford the mortgage payment if the rate rose to the cap.
Interest-only mortgages allow you the option of making only interest payments on your loan for a certain period of time, typically five to seven years. After this period, the loan converts to the original terms and the monthly payment will jump because you will now pay interest plus principal over a shortened period of time. As tempting as these lower initial payments may be, an interest-only mortgage can be risky. If you can't make the payments when they go up, you risk foreclosure or the prospect of trying to sell the house in a cooled-off housing market.
Find out if you qualify for special mortgage programs. For example, you might be able to take advantage of a loan through the FHA, VA, Rural Housing Service program of the U.S. Department of Agriculture, HUD home buying program, a local home buying program or first-time homebuyer programs in your area. To learn more about these programs, go to HUD's Web site.
Before You Start Looking at Houses
Pre-qualification gives you an estimate of the amount you will be able to borrow. It makes sense to know this dollar amount so you can limit your house hunt to properties that are in your price range. You can go to a mortgage broker or lender to pre-qualify for a mortgage loan.
Pre-approval is a more thorough process, but it results in a conditional approval that shows a seller that you are a qualified buyer who is well along in the mortgage process. This can strengthen your position to make an offer on a house, because the seller will know that your financing is in place.