Tag: home purchase

3 Mortgage Terms to Know: Principle, Interest, Down Payment

Posted on | by Kevin Strauss | Leave a Comment on 3 Mortgage Terms to Know: Principle, Interest, Down Payment

A mortgage is a loan that you take out to buy a home. When you get a mortgage, the home you are going to be purchasing will generally be used as collateral. If you fall behind on your repayments, the lending institution will have the right to take your house. There are different mortgage terms that can help you understand the process. These terms are principle, interest and down payment.

What Are Principle, Interest and Down Payment?

Principle, interest and down payment are different parts of the mortgage that you will be responsible for paying.

What is Principle?

The first of the mortgage terms you need to know of principle, interest and down payment is principle. The principle of your payment is what goes to the actual price of the home. Principle refers to the initial size of a loan and it also means the amount still owed on a loan. For example, if you take out a $100,000 mortgage then the principal is $100,000. If you pay off $30,000 of the principle then the $70,000 is also called the principle.

At first, when you are making monthly payments on your loan, your payments will likely go toward interest. Then the remainder applies to your principle. When you pay down the principle of a loan then you can also reduce the amount of interest you pay each month.

Besides making your mortgage payment on time, there can also be other methods in order to reduce your mortgage principle, provided that you are allowed to prepay or your mortgage permits additional payments. For example, if you make one additional payment per year then you can reduce the principle enough to pay off the mortgage sooner, five years sooner actually and can save additional money in interest.

What Is the Interest Rate?

Out of the principle, interest and down payment, one of the main concerns that many soon-to-be-homeowners have is about interest rates.

There are different things that will impact mortgage interest rates. You may think that daily mortgage rates don’t matter all that much but they do. It matters what the rate is today and what it might be tomorrow or next week. However, you aren’t able to control what the market does or what could be impacting the housing market. What can you do is be educated on interest rates and focus on the things you can control, such as your credit score and down payment.

Here are some factors that impact your mortgage interest rates:

Your Credit Score

One of the biggest factors for the interest rate you get on your mortgage is your credit score. Lenders will use your credit score as an indicator of how likely you are to pay back your loan. If you have difficulty paying back a loan and your credit score reflects that then you are more likely to have trouble with paying down bigger debts like a mortgage.

Your Down Payment

If your credit score isn’t that high then one thing you can do to lower the interest rate is make a more sizable down payment. This works to show the lender you are capable of saving and it will lower the amount you are then getting from the lender.

Your Loan Term

Many mortgage loans are either 15-year or 20-year loans. Many homeowners will choose a 30-year option but shorter loan terms can be eligible for better interest rates. There are two reasons for this. The bank will recoup the investment faster with a shorter-term loan. The lender is also going to be getting a higher payment from you every month. If you are going this route to lower your interest rate then you need to make sure you can handle the higher payment.

The Interest Rate Type

There are two types of interest rates that homeowners will need to be aware of.

An adjustable-rate loan will still start off with a lower introductory interest rate. After a set period of time, the rates will adjust to being more in line with the current market interest rates. At this time, your monthly payments change accordingly.

Fixed rates can be higher than adjustable ones but they stay the same over the entire length of the loan and ensure that you have the same payment each month. You can decide whether you get a fixed or adjustable rate but if you choose the adjustable-rate option you need to be prepared that your payment can go up.

Of course, every option has its disadvantages. It’s important that you know them before you decide. Unfortunately, here it all comes down to picking between two not so great things. Either you’re going to pay extra if you choose the fixed-rate option, since there are additional years when you pay interest. Or your going to risk paying much higher interest than initially, if you choose the adjusted-rate option.

What Is the Down Payment?

The last thing you need to know about the main mortgage terms of principle, interest and down payment is what a down payment is. The down payment is the upfront payment you make when you purchase a home. The down payment is the portion of the purchase price that you pay for yourself out of pocket instead of borrowing. In most cases, the money will typically come from your personal savings and you can pay with an electronic payment, credit card, or check.

Down payments are usually not part of a loan. However, you may see zero down offers where no down payment is required. Even if you don’t have to have a down payment, there are benefits of having one. The down payment will cover a meaningful part of the total purchase price. For example, if you are buying a home for $200,000 and have saved $40,000 as the down payment then you only have to mortgage $160,000.

20% is widely considered the ideal down payment amount for most loan types and lenders.

There are debates about how big of a down payment you should have. You can often choose how large the down payment should be but the decision isn’t always that easy. Some people believe that a larger down payment is better, while others think that it’s best to keep the down payment as small as possible.

What Are the Benefits of a Bigger Down Payment?

A larger down payment will help you borrow less. The more you pay upfront, then the smaller your loan will be. This means you will have a smaller principle but larger interest costs over the life of the loan. You could benefit from lower payments.

Lower Rates

You may qualify for lower interest rates if you put more down. Lenders will usually like to see a larger down payment since they can easily get more of the money back if you default. When you reduce your lender’s risk then you can also reduce your interest charges.

Avoid Mortgage Insurance

When you are purchasing a home, you can avoid private mortgage insurance and other fees with a larger upfront payment. On FHA loans, mortgage insurance costs will decrease with a larger down payment. You may be stuck with private insurance throughout the life of the loan unless you refinance at some later time when you have paid more on the home.

Smaller Monthly Burden

A lower monthly payment can make it easier for you. If your income changes due to a job change or loss then a lower payment can give you more wiggle room, which is always helpful. You can also save more for an emergency fund or other improvements to the home.

Future Borrowing Power

A lower payment makes it easier to qualify for additional loans in the future. Lenders will want to see that you have more than enough income to meet monthly obligations and will evaluate finances with what is called a debt-to-income ratio.

Potential Equity

Occasionally you can borrow against an asset such as your home and use the asset as collateral. If you put down more than 20% of the home you can enjoy price appreciation and may be able to pull funds out of a home equity loan.

What Are the Benefits of a Smaller Down Payment?

A smaller down payment appeals to a lot of people because you don’t have to come up with as much money.

Allows You to Buy Sooner

When you are trying to save 20% for a home purchase it can take a while. For some, this can take even decades and this may not work in your situation.

Emergency Reserves

If you are able to save up a significant amount then it can be scary to part with all that money. You may be wondering what you will do if something happens, such as health problems or if your car breaks down. Putting all your free cash into the house means your money is tied up in something that can be hard to sell.

Resources for Improvements

When you have a smaller down payment, you get to use the cash you keep to help with inevitable improvements and repairs.

Opportunity Cost

You may want to use the funds for other purposes, such as growing your business or retirement savings.

The decision about whether or not you choose to go with a larger or smaller down payment will depend on different factors. The best scenario is you have a solid emergency fund to deal with any surprises and you aren’t robbing this fund to make your down payment.

What About Lender Requirements for a Down Payment?

Lenders can set minimum requirements for down payments but you can always choose to go with a larger down payment. Remember that a larger down payment will reduce the risk for the lender.

Down payments can also have a psychological impact. A larger down payment shows lenders that you have more skin in the game because you have more of your own money at stake. This means you may be more likely to keep making payments. For home purchases, 20% is a significant number. When you pay at least 20%, you can avoid paying for mortgage insurance.

When Mortgage Interest Rates Are Low, Housing Prices Rise

Housing prices and interest rates do vary from market to market and even month to month. Since many people will base what you can afford on monthly payments, you are likely to take on more debt if the interest rate is good as long as you keep payments under control. Supply and demand say if people are paying more for housing then the housing prices go up.

Conclusion

The principle, interest, and down payment are three very important mortgage terms that you will need to know when mortgage shopping. All three items affect each other. The larger the down payment, the smaller your interest rates may be and the smaller your interest rates then the less you will be paying each month. The principle, interest and down payment will also affect your choices if you want to refinance your home. Knowing how a mortgage works can help you make the best decision about shopping around and knowing when it’s the right time to apply for a mortgage.

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Mortgage Loan Basics Spelled Out: Lending 101

Posted on | by Blaine Koehn | Leave a Comment on Mortgage Loan Basics Spelled Out: Lending 101

Let’s talk about mortgage loan basics.

Although they are often the largest debt an individual will experience in their lifetime, mortgages are a wonderful creation. Imagine if you had to pay cash up front for any home you wished to purchase. How many bedrooms would you have in that scenario? How many square feet? If it were me, I’d probably have to forego having a roof for the first year or two until I could save up for such luxuries.

Mortgages also keep interest rates moderated. Because the property acts as natural collateral for the loan, lenders are able to be somewhat flexible with their terms. It’s not that they want to take your home, but it does give them a safety net of sorts so that they can reasonably take the risk of loaning you funds to begin with.

Get Introduce Yourself With Mortage Loan Basics

A mortgage is a loan on the property – for example, your home – which is paid back over time to the lender along with an agreed upon interest rate. What makes it different than a simple “loan” is that the lender has the right to take over the property if payments are not made. This is sometimes called having a “lien on the property”. In other words, you don’t fully own the property until the last payment is made. That’s called “paying off your mortgage.”

How Does a Mortgage Work?

Because we’re talking mortgage loan basics, let’s assume we’re talking about a home mortgage – the most common type of mortgage.

You find a home you wish to purchase. Let’s say you have $20,000 in savings, but the home is $140,000. You do some mortgage loan shopping and decide on Morty’s Mortgages. Morty is willing to loan you the full $140,000, but in return, you essentially “pledge” your house to Morty. If you miss too many payments, Morty can take your house and sell it to someone else to recoup his losses. Since you have every intention of making your payments, you decide to finance through Morty.

The thing is, you’ll be paying back more than $140,000 to Morty. How much more depends on several factors, the biggest of which is the interest rate. There are two basic types of interest on mortgages – “fixed-rate” and “adjustable rate.” Understanding the difference is Mortgage Loan Basics 101.

Statistic: Homeownership rate in the United States from 1990 to 2021 | Statista

Fixed-rate Mortgage

A fixed-rate mortgage is one in which your interest rate remains the same for the life of the loan. The monthly payments stay pretty much the same (there are other costs besides interest, but we’ll get to those) from your first payment to your last. These are the most typical type of mortgage and sometimes simply referred to as a “traditional mortgage”. The payments are generally structured so that your early payments go towards the interest on the loan. Over time, your payments apply more and more towards the principal of the loan – the actual money you borrowed to buy your house.

You’ll sometimes hear the term “amortization” used to describe this system. I wouldn’t get too sidetracked by it; it’s pretty much the universal way things are done when it comes to mortgages. The important thing is that the amount of your monthly payment devoted to principal plus interest stays the same, even if how much of each payment goes where evolves over the life of the loan.

Awesome! But What Are the Down-side?

The only down-side to a fixed-rate (“traditional”) mortgage is that market interest rates change regularly. Daily mortgage rates fluctuate naturally, and over time they can rise or fall considerably. Either way, you’re committed to whatever it was when you first took out the home loan. If the difference is significant enough, some homeowners elect to refinance their mortgage – to essentially start from scratch, treating the balance on the mortgage as if it were a brand new home loan.

Because there are other costs associated with the process, this only makes sense if the difference in what you’ll pay is substantial over time. We should cover a few more mortgage loan basics before we address refinancing.

Adjustable-rate Mortgage

The other type of home loan is an adjustable-rate mortgage. An adjustable-rate mortgage fluctuates with market interest rates. What determines daily mortgage rates gets a bit hairy, but basically they’re the result of three interwoven factors:

The Rate Set by the Federal Reserve (often simply referred to as “The Fed”).

You hear about this in the news from time to time depending on what’s going on with politics and the economy at the moment.

Investor Demand for Treasury Bonds and Related Low-risk

When big-money individuals or institutions don’t feel good about playing the stock market or whatever else they might normally do to grow their wealth, they invest in these.

How Good the Banking Industry Is Feeling at the Moment

OK, not how they’re feeling, exactly, but what they perceive to be their current risk and potential reward. This is the closest element to what we were taught in high school about “supply and demand” and the “free market” and all that.

If you really want to dive in more to these factors and how they shape mortgage rates, be my guest. I’ll be honest and tell you that the details make my head hurt and my eyes glaze over a bit, so forgive me if we move on.

In December 2021, the average mortgage loan exceeded 313,000 U.S. dollars, up from 204,000 in 2012.

Source: statista.com

Some lenders offer a “hybrid” of fixed and adjustable-rate mortgages. You’ll agree to a low, fixed interest rate for a specified length of time – say, the first five years of the loan. After that, the rate is adjustable based on market rates. The idea is that new homebuyers lock in a “grace period” of sorts at a lower rate than would be possible with a traditional fixed-rate mortgage. If you’re new to the adult world or just starting a family, the assumption is that a few years down the road you’ll be in a better position to tackle a higher house payment in exchange for that initial period of smaller payments.

Other Payment Factors

Either way it’s figured, interest plus principal is the bulk of your payment each month. Those are fundamental mortgage loan basics. But they’re not all of it. Remember those other factors in the cost of the loan we mentioned above? The two most common elements packaged with your mortgage payment are insurance and taxes.

Most lenders will expect you to purchase enough insurance to cover the cost of the home in case of fire, flood, meteor shower, etc. Remember – your home is collateral for the loan, and it’s not unreasonable for the lender to expect their interests to be protected. Depending on the details of your coverage, your monthly payment can go up (or down) over time based on changing insurance rates.

The other way lenders protect themselves is by making sure you’re able to pay any property taxes associated with your home. If you don’t pay your taxes, the government might take your home and then both you and the lender are out of luck. Lenders guard against this by estimating the annual property taxes and dividing that amount by 12 months, then simply adding it to your required mortgage payment.

But Here’s the Trick

The folks doing the estimating and the folks determining your actual property taxes each year aren’t the same folks. Besides, property taxes go up and down depending on any number of factors. That’s where your “escrow account” comes in. As you make your monthly payments, they take the amount set aside for taxes and put it into “escrow” to be paid to the government come tax time. If your escrow has too much, you’ll get a small refund. If there’s too little, you’ll get a bill asking you to add a bit. Depending on the details of your mortgage, this might increase (or decrease) your monthly payments as adjustments are made to cover those taxes.

If all of this seems a bit overwhelming, don’t panic. Many people live long, happy lives without all the big words and complex financial computations. Our goal for now is to have a better general understanding of mortgage loan basics. Honestly, just by having read this far, you already know more than most.

Whether that’s frightening or reassuring I will leave up to you.

Understanding the Mortgage Process

Now that we’ve talked about some of the technical stuff, let’s step back and walk through the most likely scenario in which you’ll be utilizing your new mastery of mortgage loan basics – buying a new home.

Home Buying Step 1 – Find a Lender

I know, I know – house shopping is the fun part. Imagining what you’d do to this kitchen or how you’d utilize that den, just like on all those TV shows. But the right mortgage and mortgage provider is essential to a positive home-buying experience. Shop your options first, before you’re all giddy over the closet space. It’s easier to pay attention to things like interest rates and closing costs that way.

Home Buying Step 2 – Get Pre-approved

You get two mortgage shopping tips on this one. First, pre-approved financing is pretty much required when buying a house. Some realtors won’t even start showing you properties until you’ve got the money lined up. And a pre-approved mortgage makes it much easier to move quickly on a home you really want. Your mortgage provider will even give you an official letter showing how much you’ve been approved for just to keep things official. This isn’t unexpected – it’s mortgage loan basics.

Second, the “pre” in “pre-approved” here doesn’t mean the financial stuff is settled and over. It merely means you have a solid indication of how much you can spend and that your lender is reasonably certain you’ll qualify to borrow that amount from them if you choose to buy a house. That’s when the real paperwork begins.

Home Buying Step 3– Look at Homes

Finally, the fun part! Don’t be that person who finds something wrong with every house, but neither should you jump at every opportunity. Make a short list of must haves, wants, dislikes, and must avoid, and do that part well ahead of time before you’re caught up in the moment. Then, refer to it as you go. Even if you modify it along the way, it will help you keep focused and remember your priorities.

Home Buying Step 4– Make an Offer

This is where a good real estate agent is so important. They can help you figure out a reasonable starting offer based on activity in the market, the area, the home itself, etc. If homes are selling quickly, it may be pointless to make an offer below asking price. At the same time, there’s usually no harm done by a little cautious negotiating. It doesn’t have to be all about the asking price, either – sometimes sellers will agree to leave the washer and dryer or replace that weird section of carpet instead of lowering their asking price.

Home Buying Step 5 – Brace Yourself (Now the Real Paperwork Begins)

If your offer is accepted, the lender will require you to complete a mortgage loan application and to submit documentation related to your income and financial history – pay stubs, W-2s, bank statements, tax returns, etc. These will be evaluated by an underwriter, whose primary function is to study the documentation provided and verify that everything is in order. There are lender requirements to be met and government guidelines to be followed and the whole thing can make your head spin a bit if you let it.

If it makes you feel any better, the underwriter is also measuring the value of the property in question and making sure it meets all sorts of requirements and guidelines as well. They may order a value assessment or other inspections if there are questions. These are all mortgage loan basics; it doesn’t mean there’s a problem.

Possible Questions During the Underwriting Process

You may be asked about events in your financial past. Where did this deposit come from? Why was this debt written off? What happened in such-and-such year that caused this change? None of this is personal – it’s just tedious. Answer as completely and honestly as you can, and keep taking deep, slow breaths. On the other hand, you may not be asked anything at all. That’s normal as well.

Once the underwriter approves everything, you are “clear to close.” Everything is sent to a title company chosen by the lender (because there haven’t been enough people involved in the process yet).

Home Buying Step 6 – The Closing

Let’s talk good news and bad news here.

The good news is that you’re almost through the paperwork/financing/questions/approval part of the home-buying process. This is the last stage of small print and legal details.

The bad news is that if this is your first closing, there’s simply no way to be prepared for the volume of papers you’re about to be asked to sign or initial. Your next lesson in mortgage loan basics? Warm up your writing hand.

While you should always pay attention to anything you’re signing, nothing presented at this stage requires major decision-making or new action on your part. The representative from the title company will explain as you go and let you know which parts you should care about. While this part is tedious, it’s not hard. Traditionally, you’ll get the keys to your new home at the end of this part. Congratulations!

Oh – one last critical detail. You will be expected to bring a certified check or something comparable with you to cover your down payment and closing costs. These often include an initial escrow deposit and various fees to pay all the different people involved in the process up to this point. Your realtor will be able to let you know exactly how much this needs to be and what’s covered, so it won’t be a surprise. They’re not the same in every situation, and sometimes the seller agrees to take on part of these expenses as part of the negotiations. All that has been settled by this point, however, and it’s time to hand over your first check and get those keys.

Home Buying Step 7– Move In

This isn’t technically part of the mortgage process, but it’s sometimes helpful to remember why you’re putting yourself through all of this. Why are you dragging yourself through mortgage loan basics? It’s all been for this moment. Try to enjoy it.

Types of Mortgages

These aren’t entirely distinct forms of mortgages so much as variations you may encounter as you begin the process. A given mortgage arrangement can involve several of these factors together, or prove so straightforward that most of this terminology never even comes up. Still, knowing some terms common in mortgage loan basics might help you ask better questions of potential lenders.

Fixed-rate Mortgages

We talked about these above. With a fixed-rate mortgage, your monthly payment stays largely the same throughout the life of the loan (other than small adjustments based on changes to your taxes or insurance).

Adjustable-rate Mortgages

You probably remember this one as well. Most adjustable-rate mortgages start off as “hybrids” in which you commit to a lower initial interest rate for a fixed amount of time before throwing yourself on the mercies of the market.

Balloon Mortgages

Ballon Mortgages are fairly uncommon. For most of the term of the loan, you’d pay very little. Then, at the end of the time specified by the terms of the loan, the full balance would come due. This sort of mortgage only makes sense if you have unusual circumstances involving guaranteed funds down the road.

Interest-only Mortgages

These are similar to the balloon structure above, but are structured so that the increase in payments over time is more gradual. Borrowers pay only on interest for a predetermined amount of time, then begin paying on the principal as well. These are sometimes a decent option for some first-time homebuyers just starting their careers.

Government-insured Home Loan Options

Federal Housing Administration Mortgages

FHA mortgages are backed up by the government, protecting lenders in case of default. This allows lenders to offer lower down payments and better terms, although you’ll have to provide proof of appropriate insurance.

The U.S. Department of Agriculture (USDA)

It has several options for rural homebuyers who meet their requirements. They’re looking for borrowers with limited resources but who can demonstrate a predictable income, however modest. The mortgage process is handled by the Rural Housing Service (RHS), a subdivision of the USDA.

The U.S. Department of Veterans Affairs (VA)

It provides mortgage assistance to veterans or active military members and their families. As with FHA loans, the government guarantees payment to lenders in order to secure the best possible terms for borrowers. There’s also an option for no down payment, which is more common than it used to be but still unusual.

Other Government-backed Mortgages

They vary from state to state, or even region to region. There are programs to help those with Native American ancestry purchase a home, or to promote the revitalization of certain cities or parts of some states. Ask your realtor what might be available.

These are only a few of the most common variations you may encounter. Pay attention to the details. What does each mortgage option mean in terms of the total you’ll pay for your home? What does it mean for your monthly payments now, and in five years, and in fifteen years? Not to forget, what obligations are you taking on, and what can you reasonably expect from other interested parties?

Government Mortgage Loan Type

When Should You Refinance?

There are Several Good Reasons:

  • Interest rates are so much lower than it’s worth the time and costs to secure the lower rates for the remainder of the loan
  • You want to shorten the length of the mortgage so that your home will be paid more quickly
  • It’s advantageous to change from an adjustable-rate mortgage to a fixed-rate mortgage, or the other way around
  • You’re using your home as equity to finance a major purchase
  • You’re consolidating your total debt and refinancing is part of that consolidation

Refinancing isn’t free, so make sure the amount you’ll save in the long run makes the process worth it. If you’re still considering refinancing your mortgage, check out these mortgage calculators for more details to consider.

Where to Shop for a Mortgage?

We thought you’d never ask.

There’s no harm trying traditional sources – your local bank or credit union or other favorite financial institution. But in the 21st century, you have numerous online options as well. That’s where we come in. We’re not trying to sell you anything or tell you what to do about your mortgage. That’s not our business. What we’re good at is connecting you to quality lender options based on the information you share with us about your needs and background. The rest is between you and them.

In Conclusion

It can be a bit intimidating at first, but let me offer a few mortgage shopping tips. Remember that you are the customer. In the end, you’re the person everyone else should want to be happy. Just keep your eyes open and mind focused, and don’t shy away from asking for clarification of anything you’re not quite sure about. It’s their job to make sure you know what’s going on; it’s your job to be as prepared and as upfront as possible. Know your mortgage loan basics and breathe.

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