Understanding Mortgages
What is a Mortgage?
A long-term loan for property, and the buildings on the property, is called a mortgage. Lending institutions such as banks and mortgage companies are the largest mortgage lenders, but some credit unions offer long-term loans. Sometimes a seller will finance the home they are selling and some mortgages are assumable from the current homeowner.
Lenders offer loans of their own deposits, but usually make loans and sell them to investors. Historically, loans made to be sold have followed strict guidelines, but mortgage products with more flexible guidelines have been developed.
Down Payments
Most mortgages generally require down payments as a firm commitment from the buyer to the lender of the buyer's intention to repay the loan.
Some lenders will offer mortgages for 97% or 95% of the value of the property. The borrower, then, is required to make only a 3% or 5% down payment.
Generally, when a mortgage is made with less than a 20% down payment, mortgage insurance is required. Some lenders may be more restrictive.
Types of Mortgages
Frequently mortgages are described by the type of insurance they carry. Mortgages are insured against default (failure to pay) by the borrower. The Federal government insures mortgages through the Federal Housing Administration (FHA) and the Veterans Administration (VA). The Department of Agriculture has a department named Rural Economic Community Development (formerly FmHA) which guarantees mortgages for properties in rural areas. Private companies offer mortgage insurance too.
When you get an FHA loan -- that means your loan is insured by the FHA. Conventional loan is the name given to non-government insured loans.
Interest Rates
The interest rate is the lender's charge for your use of the funds. Lenders charge a rate based on their current cost of funds. When comparing lenders consider the rate, the term, and points.
Mortgage Options
The most common type of mortgage currently is a 30-year fixed interest rate mortgage insured by the Federal government. There are many other kinds.
Adjustable Rate Mortgages (ARMS) start at a low rate which adjust following a set schedule. If you are training in a career that pays more money after training is completed, you might choose a lower payment to get started in your home, expecting to have the house payment increase in the future.
Balloon Mortgages have low monthly payments, but require re-financing or pay off at the end of the initial term, sometime three years. If you will be moving and selling at the same time your balloon mortgage is due, this might be an option for you.
THDA Mortgages are fixed rate and designed for families of low or moderate incomes. THDA mortgages are offered at lower-than-market interest rates through local lenders.
How Much Can I Borrow?
Keep in mind the amount you feel comfortable borrowing. You don't have to borrow as much as the lender is willing to lend.
A lender's first guideline says that a family, or household, should spend no more than 28% of its before-tax income (gross income) on household expenses. Household expenses include mortgage principal and interest, hazard insurance, real estate taxes, and mortgage insurance.
The second guideline says that housing expenses and other long-term debts combined generally should not be more than 36% to 41% of gross income. Long-term debt includes car loans, credit card payments, student loans or medical bills.
These guidelines, called ratios, are flexible. Additionally, some lenders offer special programs for families of low or moderate incomes. Generally, a lender expects a household can afford a mortgage debt of two and one-half times annual income. If your household income is $28,000, you might afford a $70,000 mortgage. See the chart which shows principal and interest payments for different interest rates and different loan amounts for a 30-year fixed rate mortgage.
Usually the monthly payment includes more than the principal and interest. Local property taxes, mortgage and hazard insurance premiums are examples of additional payments, portions of which are collected monthly and escrowed until due. Other mortgages allow the borrower to handle on-going taxes and insurance premiums.
You can reduce your monthly payment by paying more money at closing. A larger down payment reduced the size of the mortgage and the future payments.
Principal and Interest Payment Only
Loan Amount 6% 7% 8% 9% $30,000 $180 $200 $220 $241 $40,000 $240 $266 $294 $322 $50,000 $300 $333 $367 $402 $60,000 $360 $399 $440 $483 $70,000 $420 $466 $514 $563 $80,000 $480 $532 $587 $644 Points and Closing Costs
There are one-time taxes and fees required in making a mortgage. Some of these costs are charged when you apply for a mortgage, others are charged at closing, when the loan becomes official.
Lenders usually charge points as part of their cost to make the loan. One point equals 1% of the mortgage amount. Some points and closing costs can be wrapped in, or added, to the loan amount. If not added to the loan, closing costs are paid by the buyer at closing.
A sample list of closing costs follows:
- Loan application fee
- Credit report
- Property appraisal
- Loan origination fee (covers administrative costs of the lender)
- Title search and title insurance fees
- Hazard insurance
- Private or Federal mortgage insurance premium
- Inspection fees (structural and mechanical, termite)
- Survey fee
- Recording fees (local government office)
- Transfer fees
- Buyer's attorney's fees
- Deposit for appropriate escrow items (insurance, taxes, mortgage insurance, etc.)
- Pro-rated interest until the first regular payment
Exact closing costs will depend on fees charged in your area, how much you are borrowing, how you finance your mortgage, and your closing date, i.e., where it falls within the month. Closing costs are in addition to your down payment and generally are about 5% of the loan amount.
If you are considering a home in a neighborhood with a homeowners' association, check for an annual fee. Group ownership of amenities and exterior maintenance of condominiums add to your costs. Any costs related to the type of ownership should be considered in your budgeting.
Homebuyers Education
A lot of thinking and planning is necessary for a successful home buying experience. Many lenders, real estate professionals and not-for-profit organizations offer homebuyers education classes to help people organize their plans. Topics include different kinds of mortgages, down payment requirements, underwriting criteria, and special programs to encourage homeownership with reduced costs.
THDA maintains a list of trainers approved to teach about our programs. Check our Homeownership Education page for more information and to check for a trainer working in your area.
