In the last decade, my wife and I have taken out three separate mortgages. Each time, we had to consider a variety of mortgage options. Personally, we chose a conventional 30 year fixed interest rate mortgage every time. However, we did consider many other types of mortgages in the process. If you’re considering taking out a mortgage, whether it is your first mortgage or your fifth mortgage, you should strongly consider the following parts of mortgages to help you choose the right mortgage for you.
Parts of Mortgages
A single mortgage usually isn’t too complex. That said, there are many factors you need to consider when you’re comparing multiple types of mortgages. Different mortgages offer different options for each component of the mortgage. Here are some of the main factors we considered when choosing the right mortgage for us. You should do the same.
Fixed Rate vs. Variable Rate
One of the first factors to consider in deciding on a fixed interest rate or a variable interest rate mortgage. Fixed interest rate mortgages have the same interest rate for the entire life of the loan. Variable interest rate mortgages have interest rates that can increase or decrease over time, usually based on a benchmark interest rate such as LIBOR or the prime rate.
In general, variable interest rate loans usually have a lower initial interest rate than fixed interest rate loans in the current environment. On the other hand, if interest rates increase while you’re repaying your mortgage, the interest rate you pay in the future could very well be higher than the interest rate you could obtain with a fixed interest rate loan.
If you believe interest rates will decrease in the future, you may want a variable interest rate mortgage. Just make sure you can afford the payments if interest rates end up increasing to the cap listed in your mortgage. If you believe interest rates will be increasing, it may make sense to lock in the current low interest rates with a fixed rate mortgage.
Another important factor few people consider when taking out a mortgage is the length of the loan. Believe it or not, you can usually get mortgages for many time periods. The most common mortgages are 30 year and 15 year mortgages. Some lenders also offer 5, 10, 20, 25 and 40 year mortgages. In general, the longer the loan length the more you’ll pay in interest over the life of the loan. Also, the shorter the loan length the lower interest rate you can usually obtain on a loan.
Most loans require a down payment in order to obtain the best interest rates possible. While some loans do not require down payments, most require anywhere from a three and a half percent down payment to a 25 percent down payment. If you cannot afford to put down at least 10 or 20 percent down payment, you’ll likely have higher mortgage costs.
Additionally, you want to consider if you can really afford to buy a home at this point in your life or if you’re stretching yourself financially to become a homeowner. Remember, you should not use your emergency fund money for a down payment.
Private Mortgage Insurance
If you don’t put down a large enough down payment, usually 20 percent, you could have to pay private mortgage insurance (PMI). While PMI may not seem like a big deal, it can easily add hundreds or thousands of dollars per year to your mortgage payment. While some loans allow you to remove PMI after you achieve a certain amount of equity in your home, other mortgages require you to pay PMI for the life of the loan.
No matter which type of mortgage you choose, each individual lender will have different closing costs. Closing costs are all of the various fees, costs and prepayments required to issue a mortgage on your home. They often include prepaid insurance and prepaid property taxes. Closing costs also include fees to professionals such as title companies, surveyors, home inspectors, notaries, lawyers and other professionals. They may even include homeowners’ association fees, new buyer fees and points to buy down your interest rate.
The important thing to realize is you’ll either pay for closing costs with every type of loan or you’ll receive a higher interest rate to offset the cost of your closing costs. Some loans require more closing costs than others, so make sure to discuss this with your lender when choosing a type of mortgage.
Types of Mortgages to Consider
There are many types of mortgages to consider. Some mortgages are run by federal programs while others are more traditional loans that investors buy. Here are some of the major types.
Conventional mortgages are one of the most common types of home loans. These loans usually offer fixed rate or variable rate options, as well as different lengths of the loan. These loans aren’t insured or guaranteed by the federal government. That means you usually don’t have to jump through as many hoops as other types of mortgages. That said, you will have to make sure you and your loan conform to a set of standards issued by Freddie Mac or Fannie Mae, as many lenders like to sell conventional mortgages to these mortgage giants. Those standards usually include larger down payments and higher credit score requirements.
An FHA loan is a mortgage insured by the Federal Housing Administration (FHA). These loans require a down payment of as low as 3.5 percent. FHA mortgages are usually easier to qualify for and may offer lower closing costs. The big downside to a FHA loan is private mortgage insurance, which must remain for the life of the loan. You’ll be charged an upfront PMI fee of 1.75 percent of the value of the loan. You’ll also have to pay an annual fee which is usually around 0.85 percent. These fees can add up, especially if you stay in the home for a long period of time and never refinance your mortgage.
USDA loans are guaranteed by the United States Department of Agriculture. Thanks to this guarantee, you may qualify for a home loan with no down payment at all. However, no down payment means you’ll have to pay PMI. PMI for USDA loans is currently a one percent upfront fee and a 0.35 percent annual fee based on the remaining loan balance. To qualify for a USDA loan, the home you’re purchasing must be in a qualified rural or suburban area. You can check using this map. You will also need to meet certain credit requirements and have an income less than the current income limit for your area.
If you’re a member of the military or a veteran, you may qualify for a loan partially guaranteed by the Department of Veterans Affairs. These loans require no down payment, but they do require a funding fee of up to 3.3 percent. The different between the 3.5 percent FHA loan down payment and the up to 3.3 percent VA funding fee is the FHA down payment builds equity in your home while the VA funding fee does not. VA loans do not require PMI and also limit fees that you may have to pay when taking out a loan. This saves you money versus FHA loans, especially if you live in your home for a long time without refinancing. You will have to meet income and credit requirements, but they are often less restrictive than other loan programs.
Personal Circumstances to Consider
Chances are you may qualify for more than one type of mortgage. If you do, you’ll need to figure out which is the best for you. In order to do this, my wife and I made sure to look at our personal circumstances.
When Do You Want to Be Debt Free?
First, we wanted to make sure we would be debt free before we retired. That meant we could still take out a thirty year mortgage because we’re still young. If we were closer to retirement, we wouldn’t take out a loan longer than the number of years until we retired. Learn the 3 principles to make retirement planning not so daunting.
How Long Do You Plan to Stay in Your Home?
Next, we considered how long we planned to stay in our home. We can’t imagine moving any time soon unless there is a drastic change in our life that requires us to leave the current area we live in. For that reason, we decided a longer, fixed rate mortgage could help us lock in the current interest rate. If you’re only planning to be in a home for a few years, a lower interest rate variable rate mortgage may save you money.
Is Paying More up Front Worth Long Term Savings?
If you qualify for a conventional mortgage and low down payment mortgage options, you’ll have to decide if putting a larger down payment down now is worth saving money in the long run. Conventional mortgages with higher down payments can save you a significant amount of money if you qualify for the best rates and plan to keep the mortgage for a long time. Only you can decide which is best for you or if you should pay off your mortgage early.
There are other types of mortgages in addition to the main types covered above. Those exotic mortgages are usually pretty unique to various situations. You should always investigate all of your options. Run the numbers and pick the mortgage loan that works best for you. When we looked at our options, we decided putting more down up front was well worth the long term savings. We plan to stay in our current house for years to come. We figured we should get the best interest rate possible with no PMI. We’re glad we did.
The excitement of buying a house is overwhelming – the mortgage loan process, on the other hand, can be intimidating.
Is there where you are right now? Are you unsure of what to do, how to do it, and where to even begin?
If you hope to apply for a mortgage loan soon but don’t know what to expect, continue reading the most important steps you should know.
Step One: Apply for the Loan
The mortgage loan process always begins with filling out an application. This application will ask you for your personal details and a financial statement. You will have to agree to a credit check when submitting the application too.
The lender will need all this information to determine several things:
- If you qualify for a loan.
- The type of loan program you qualify for.
- Any steps you need to take before you qualify for a loan.
It may take several days for your lender to get back to you after applying. During this time, you shouldn’t be surprised if the lender calls you to ask you questions.
Lenders need a lot of details to make a decision about a loan application, and they will call if they need to.
Step Two: Discuss Your Options With the Lender
If the lender approves your loan, you’ll need to sit down with them and talk about your options. It’s during this time when you’ll find out what type of loan program you qualify for or if you qualify for several types.
The type of loan you qualify for will reveal certain conditions of the loan. For example, the loan type will determine how much money you must put as the down payment. It may also restrict what type of house you buy.
Step Three: Choose a House
The approval process will also reveal to you the amount you can borrow. You can use this amount as the basis of your budget as you shop for a house.
You will need to find a house to buy, make an offer on it, and get an acceptance from the seller before you can proceed with the mortgage loan.
You should always take this step slowly to make sure you choose a house that really fits your needs and that is in the right location. You can read more here to learn more about this part of the process.
Step Four: Wait for the Lender to Work Through the Mortgage Loan Process
The next step of the process can be grueling at times as this is the stage where the lender has to complete a lot of different steps before they will actually give you the loan.
The lender will order an appraisal to verify the home’s value. The lender may require that you hire inspectors to perform home inspections. Once the list of steps is complete, the lender then sends the entire file to underwriting.
You cannot get your mortgage closing date until underwriting approves your file, and this can take some time. Once approved, though, you’ll get a closing date and be on your way to becoming a homeowner.
Ways to Learn More Before You Proceed
Are you interested in learning more about the mortgage loan process?
If so, read up on it. It’s important to know what the process is step-by-step before you apply for a loan. You can check out our blog to learn more about the important steps you’ll have to take when applying for a mortgage loan.
Are you getting ready to embark on purchasing a new home? Or maybe you already have a home and you’re looking at ways to unlock its existing equity. Either way, acquiring a home mortgage has both its perks and challenges as well. The main thing is understanding what the different loan types are and exactly how they can benefit you. Qualifying and accessing funds is also important. Here are just a few ways to determine what home mortgage type may be the best for you.
Government Or Conventional?
Once you’ve decided you want to purchase your first home or another home, you’ll have to decide if you want to go for a loan funded by the federal government or your local banking institution. Both have benefits and drawbacks. When using federal government money, sometimes there are certain restrictions. You may have to have private mortgage insurance on the loan for the first few years to secure the risk of default. Government loans are limited on funding, but the main perk is that they benefit low-income people and first-time home buyers. Credit terms are lax in comparison to most conventional loans through banks and mortgage companies. With a conventional mortgage, you’ll most likely have to have excellent credit and a significant down payment of at least 10 percent or more, depending on the lenders, like Eagle Home Mortgage and their own credit criteria. Make sure you know your credit score before applying. The higher your score- the more likely you’ll get final approval through underwriting.
Reverse Mortgage Or Second Mortgage?
Do you already own a home with a lot of equity and you really want to tap into the money for retirement or to pay off debt? Two things that may benefit you are a second mortgage or possible a reverse mortgage. Both allow you to access cash from your home’s equity. So it’s good that you’ve either made improvements over the years to your home and have it paid off or almost paid off. A second mortgage allows you to get the funds you need to pay off bills or use it for whatever you wish. The cons are that you need to pay off the loan, and you may lose equity while the loan is still outstanding.
With a reverse mortgage, the main caveat is that you have to be a specific age, typically over 55 and you need to have significant equity in the home. The cons are that you lose ownership of the home and will be unable to use it as a future investment. Getting your home appraised and finding out your pay off balance are important things to do prior to applying for either type of loan.
Adjustable Rate Or Fixed?
Most home loans vary in their terms and requirements, but one thing that is always prevalent is the interest rate. The goal is to acquire a loan that has low interest, so you’re paying more on the principle over the course of the loan period. Some lenders entice applicants with an adjustable rate mortgage. This starts off low and makes the initial payments low, but as the market fluctuates, so can your payment. This can be a gamble, especially if you’re on a fixed income. Before applying, gather proof of your income and bank statements. This will make the application process faster.
15 Or 30-Year Term?
Once you’ve decided on what type of loan you want, you can then decide how quickly you’ll want to pay it off. Its common sense to know that the quicker that you pay off a loan, the less interest overall you’ll have to pay. Most home mortgages have a 30-year term. This keeps the monthly payment low and gives the homeowner plenty of time to pay off the principle. If you opt for a 15-year term, your payment will be double, but the benefit is that your interest rate might be lower. It depends on what your FICO score is and what the exact specifications of the loan are.
Another option to save money without risking a high monthly loan payment each month is to make double payments or apply additional funds to the principle of your loan as often as you can. For example, if you get a bonus at work or have extra money left over in savings one month, apply this amount to the principal of your loan. You’ll have to call your mortgage company and specify that you want the funds allocated this way or it may be applied to escrow or be held in a separate short-term account.
No matter what you decide, know the facts before you finalize your mortgage documents. Talk to your lender, who will be able to help you make the final decision on one of your biggest investments.
Assuming you own a home, chances are you still have mortgage debt. Mortgage debt is often the last debt to be paid off, even if you’ve managed to pay off most other types of debt that used to be part of your life. Mortgages usually represent two to four years of gross earnings. After accounting for taxes and your expenses, your mortgage loan usually represents even more working years. However, some people are paying off mortgage loans early. The question is, does it make sense for you to try to pay your mortgage off early, too?
Paying Off Mortgage Early – Reasons To Consider It
I would imagine paying off my mortgage early would be a very freeing feeling. After all, I’d love to have a paid off mortgage and no longer have to make the largest payment in my monthly budget ever again. Unfortunately, I still have a payment, so I can’t say definitively that I’d feel free.
Paying off your loan early has a few major benefits. The largest of which is freeing up your money for other goals. While you’ll still have to pay for insurance, property taxes, and homeowners association fees, the principal and interest payment of your loan payment likely represented the majority of your monthly payment.
After you’re done with your mortgage payoff, you can redirect that money to invest for your retirement. Alternatively, you could increase your entertainment budget or do anything else you please with the money.
If those options don’t appeal to you, you could instead reduce your income by the amount of your loan payment and still get by just fine. You could take a lower-paying job you would enjoy more or you could retire early and live off of your investments.
Another commonly cited benefit of prepaying your loan is forced savings. The goal of paying off your loan early can help make you motivated enough to send in extra payments. For many people, it’s a question of whether they pay off mortgage early or invest their funds instead. However, investing isn’t as exciting as having a paid off house for many people. If that sounds like you, you might keep more of your money by prepaying your mortgage.
Reasons to Pay Your Mortgage According to Schedule
Paying your mortgage according to the 30 or 15-year payment schedule also has its own set of benefits. This is especially true with the record low-interest rates on mortgages we’ve been enjoying over the last few years.
I’ve seen mortgage rates as low as 3.25% on a 30 year fixed mortgage. I find it extremely hard to believe that interest rates on your savings accounts won’t increase to exceed the rate on your mortgage payment during some period of the next 30 years.
Inflation also helps when you don’t prepay your loan. Over time, the value of money slowly erodes. A candy bar that used to cost a nickel decades ago now may cost almost a dollar today. The same thing will happen with the money you use to pay your mortgage payments. In 20 years when you make the same $1,000 mortgage payment, you’re making today, assuming you’re using a fixed-rate mortgage, the cost will be much lower in real terms.
If you itemized deductions, you can still use your mortgage interest as a deduction on your taxes. Keep in mind, it may not help as much as you enter the later portion of your loan. That’s when interest payments become minimal and principal payments increase drastically.
With fixed-rate mortgages, even if you make early payments, your monthly principal and interest portion of your loan payment usually won’t ever change. This stinks because you’ve easily spent thousands of dollars prepaying your loan and the only benefit is you have more equity in your home. The only way to access that equity is to sell your home, get a cash-out refinance loan, or take out a home equity loan.
Should I Pay Off My Mortgage Now or Invest Instead?
Instead of prepaying your mortgage to pay off house early, you could invest your money. Due to extremely low-interest rates, most people assume investing over the long term will provide higher returns than prepaying your mortgage. No one can say for sure whether or not investing will turn out better than paying off a mortgage faster. However, investing does allow you to access your money at any time, though you just may have to take a financial haircut to get it.
The Choice Depends on What Motivates You
Choosing whether you want to prepay your loan or not is often a complex decision. Fortunately, you can make the decision solely on what makes you happy and your personal goals. If you know you’ll sleep better at night paying your mortgage off early and don’t mind losing the benefits of waiting to pay off your loan, go ahead and pay it off. However, if you know you’d be better off paying your mortgage according to schedule and investing the difference, don’t let those that prepay their mortgages pressure you into a situation that isn’t optimal for your family and your finances.