Buying a new home? Congrats! You probably need a mortgage, but don’t let that get you down. Let us guide you through some of the terms to help you feel empowered to face your banker with confidence.
When I got my first mortgage, I was both over the moon and terrified. I was putting down roots for the first time in a long time but the paperwork and all of the options were beyond overwhelming. How big of a down payment should I make? What length of mortgage should I choose? Why is everyone high-fiving me on snatching up my own property without even a mention of these important next steps? (I’d never do that to you.)
I walked through these and many more questions with my banker and thought I’d share some of my findings so you don’t find yourself as flustered as I was.
Most people know what a mortgage is because almost everyone has one at some point in their lives. It is a loan specifically to buy real estate. Most mortgages in the U.S. are for 15 or 30 years, but some can be extended up to 40 years. You may be intrigued by the latter option, paying off your home little-by-little. But 40 years is a long time, which means you’ll pay a lot of additional interest. My advice: Think about what you can afford and try to choose the shortest mortgage you can handle without becoming “house poor.” If you’re not sure, consider a mortgage that lets you pay additional payments on your principal just in case you get a surprise bonus check (#prayforme) or a nice tax return.
While having a large down payment is recommended, it’s possible to finance a house with as little as 10-15 percent down (because we don’t all have a rich aunt Edie to leave us a fortune). There are legitimate programs that will let you put no money down and still finance a home especially if you’re a first-time homeowner. Some programs include an FHA Loan or a USDA Loan as well as a few others.
Be prepared to pay these additional fees when obtaining your loan. These costs can include attorney’s fees, preparation and title search fees, and credit report charges. They are typically around 3 percent of your loan and are often paid at the closing of your loan.
Watch the Rates
Interest rates can be tricky. Especially since they are often quoted in so many ways, making them difficult to compare. (I’m not saying they’re intentionally trying to confuse us but…)
Periodic rate: The rate you pay per payment period. For example, if you pay monthly, a periodic rate would be monthly as well. Bi-weekly payments would have a bi-weekly rate.
Annual interest rate: This is the periodic rate multiplied by the number of periods in a year. For example, a monthly rate multiplied by 12 would be an annual interest rate. This is where the problem with comparisons lies. This does not consider compounding and should not be used to compare rates of different payment periods.
Effective annual rate (EAR): The golden rate! This rate does consider compounding. Rates are generally not quoted in this way and must be converted to become comparable. Before you compare rates, always make sure they are converted to an effective annual rate to consider the effects of compounding.
The same stated annual rate is actually different once the effects of compounding are considered. Over a 30-year period, this difference can be substantial.
Variable versus fixed rate: You can choose a rate that best suits your needs. A variable rate will move along with market interest rates. This option is riskier in the sense that your interest payments will fluctuate along with interest rates meaning they could rise and fall periodically. A fixed rate mortgage has a rate that is constant for the life of the mortgage or for a period that you agree upon with your lender. A fixed rate tends to cost slightly more than a variable rate.
Adjustable Rate Mortgage (ARM): A mortgage that begins with a fixed interest rate for a period, followed by periodic resets to the interest rate and monthly payments.
Look out for…
Some mortgages have penalties for early repayment. That’s because most banks sell off their mortgages as assets, also known as Mortgage Backed Securities that make constant payments to buyers, and they don’t want you to mess with the payment schedule. Check with your lender ahead of time in case you plan to pay off your mortgage sooner.
Mortgage loans can become predatory when the borrower is led into a transaction that is not what they expected or if the lender uses unfair or fraudulent practices. An example of this might be a bait-and-switch scheme where you are promised one type of loan, and at signing, you find out you are getting something different. There are several other examples of predatory lending that you should be aware of. You can check them out on this mortgage education site. Don’t be played, navigators.