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What Is A Mortgage? Loan Basics For Beginners

Owning a house is a part of the American dream for many people. Having a mortgage is only one of the many measures that most Americans would take to become homeowners. You've come to the right spot if you're thinking about buying a home and aren't sure where to go. We'll go over what you need to know about mortgages, including loan forms, mortgage jargon, the home-buying process, and more.

A Simple Definition Of A Mortgage

A simple definition of a mortgage is a type of loan you can use to buy or refinance a home. Mortgages are also referred to as “mortgage loans.” Mortgages are a way to buy a home without having all the cash upfront. 

Who Gets A Mortgage?

The majority of people who purchase a house do so with the help of a mortgage. If you can't afford to pay for a house outright, you'll need a mortgage. There are several instances where having a mortgage on your house makes sense even though you have the funds to pay it off. Mortgages, for example, are often used by borrowers to free up funds for other investments.

Parties Involved In A Mortgage

Any mortgage transaction involves two parties: the lender and the borrower.

Lender

A lender is a financial institution that provides you with a loan to help you purchase a home. A bank or credit union could be your lender, or it could be an online mortgage provider like Quicken Loans®. When you apply for a mortgage, the lender will go at the documents and see if you meet their requirements. Any lender has its own set of criteria for who they can lend money to. Lenders must select eligible customers who are able to repay their loans with caution. To do so, lenders look at your whole financial record, including your credit score, revenue, savings, and loans, and see how you'll be able to pay back your loan.

Borrower

The borrower is the one who wants to get a loan to buy a house. You may be eligible to apply for a loan as the sole borrower or as a co-borrower. Adding more income-earning borrowers to your loan might help you apply for a more costly home. You must satisfy the residency conditions to be eligible for the loan. As a result, a person who qualifies for a mortgage would most likely have a steady and predictable income, a debt-to-income ratio of less than 50%, and a good credit score (at least 580 for FHA loans or 620 for conventional loans).

What’s The Difference Between A Loan And A Mortgage?

Any credit arrangement in which one side accepts a lump sum and promises to repay the money is referred to as a "loan." A mortgage is a form of loan used to purchase real estate. The term "mortgage" refers to a certain form of loan, but not all loans are mortgages. Mortgages are referred to as “secured” loans. A guaranteed loan is one in which the creditor pledges collateral to the lender in the event that they default on their payments. The house is the collateral in the case of a mortgage. If you don't make your mortgage payments, your lender will foreclose on your house.

How Does A Mortgage Loan Work?

Your landlord gives you a fixed amount of money to buy a house when you get a mortgage. You expect to repay the loan – plus interest – for a number of years. If the lease is paid off, you can not actually own the house. The interest rate is calculated by two factors: existing market rates and the lender's willingness to take a chance of lending you money. You may not be able to influence existing market prices, but you may influence how the lender perceives you as a borrower. The better your credit score and the less red marks on your credit sheet, the more you'll seem to be a trustworthy investor. Similarly, the smaller your DTI, the more money you'll have to put into your mortgage payment. All of this demonstrates to the investor that you are a lower risk, which would result in a lower interest rate for you. The amount of money you can borrow is measured by how much you can pay and, most critically, the home's fair market value, which is determined by an assessment. This is significant since the developer cannot lend more than the home's appraised value.

Mortgage Terminology

When you're looking for a home, you might hear some industry jargon you don't understand. We've compiled a list of the most popular mortgage terminology in an easy-to-understand format.

Amortization

A portion of each monthly debt payment will be used to pay interest to your lender, and the remainder will be used to pay off the loan balance (also known as the principal). The term "amortization" refers to how such installments are spread out over the loan's existence. Profit takes up a larger part of the payout in the early years. As time passes, a larger portion of the bill is applied to the principal amount of your debt.

Down Payment

The down payment is the money you put down when you buy a house. To get a mortgage, you almost always have to put money down. The amount of money you'll need for a down payment will depend on the kind of loan you're receiving, but a higher down payment usually means stronger loan terms and a lower monthly payment. Conventional lenders, for example, require as little as a 3% down payment, but you'll have to pay a premium premium (known as private mortgage insurance) to compensate for the low down cost. However, once you put down 20%, you'll almost certainly get a decent interest rate and won't have to pay for private mortgage premiums. You should use a mortgage calculator to see if your down payment impacts your monthly payments.

Escrow

Land taxes and homeowners insurance are a necessary part of owning a house. Lenders set up an escrow account to cover for these costs to make it easier for you. Your landlord manages your escrow account, which works similarly to a bank account. The money in the account does not receive interest, instead it is used to raise money so that the lender can submit bills for your taxes and benefits on your behalf. Escrow fees are added to your annual interest payment to cover your account. Escrow accounts are not used with all mortgages. You would pay your property taxes and homeowners insurance bills yourself if your loan does not have one. Many lenders, on the other hand, have this solution in order to ensure that the property tax and insurance bills are covered. An escrow account is expected if your down payment is less than 20%. If you put down a 20% or more, you can choose to cover these costs out of pocket or include them in your monthly interest payment. Keep in mind that the amount of money you'll need in your escrow account is determined by the annual cost of your premiums and property taxes. And, since these costs fluctuate from year to year, the escrow payout can fluctuate as well. As a result, your monthly mortgage payment can rise or fall.

Interest Rate

A monthly interest rate is a percentage that indicates how much you'll cost your loan as a favor for borrowing money per month. Fixed rates and adjustable rates are the two categories of mortgage interest rates.

Fixed Rates

Fixed interest rates stay the same for the entire length of your mortgage. If you have a 30-year fixed-rate loan with a 4% interest rate, you’ll pay 4% interest until you pay off or refinance your loan. Fixed-rate loans offer a predictable payment each month, which makes budgeting easier.

Adjustable Rates

Adjustable rates are interest rates that change based on the market. Most adjustable rate mortgages begin with a fixed interest rate period, which usually lasts 5, 7 or 10 years. During this time, your interest rate remains the same. After your fixed interest rate period ends, your interest rate adjusts up or down every 6 months to a year. This means your monthly payment can change based on your interest payment.

ARMs are right for some borrowers. If you plan to move or refinance before the end of your fixed-rate period, an adjustable rate mortgage can give you access to lower interest rates than you’d typically find with a fixed-rate loan.

Loan Servicer

The loan servicer is the company that’s in charge of providing monthly mortgage statements, processing payments, managing your escrow account and responding to your inquiries. Your servicer is sometimes the same company that you got the mortgage from, but not always. Lenders may sell the servicing rights of your loan and you may not get to choose who services your loan.

Loan Types

There are many types of mortgage loans. Each comes with different requirements, interest rates and benefits. Here are some of the most common types you might hear about when you’re applying for a mortgage.

FHA Loans

FHA loans are a popular choice because they have low down payment and credit score requirements. You can get an FHA loan with a down payment as low as 3.5% and a credit score of just 580. These loans are backed by the Federal Housing Administration; this means the FHA will reimburse lenders if you default on your loan. This reduces the risk lenders are taking on by lending you the money; this means lenders can offer these loans to borrowers with lower credit scores and smaller down payments.

Conventional Loans

The phrase “conventional loan” refers to any loan that’s not backed or guaranteed by the federal government. Conventional loans are often also “conforming loans,” which means they meet a set of requirements defined by Fannie Mae and Freddie Mac – two government-sponsored enterprises that buy loans from lenders so they can give mortgages to more people. Conventional loans are a popular choice for buyers. You can get a conventional loan with as little as 3% down. If you put down less than 20% for a conventional loan, you’ll usually be required to pay a monthly fee called private mortgage insurance, which protects your lender in case you default on your loan. This adds to your monthly costs but allows you to get into a new home sooner.

USDA Loans

USDA loans are only for homes in eligible rural areas (although many homes in the suburbs qualify as “rural” according to the USDA’s definition.). To get a USDA loan, your household income can’t exceed 115% of the area median income. USDA loans are a good option for qualified borrowers because they allow you to buy a home with 0% down. For some, the guarantee fees required by the USDA program cost less than the FHA mortgage insurance premium.

VA Loans

VA loans are for active-duty military members and veterans. Backed by the Department of Veterans Affairs, VA loans are a benefit of service for those who’ve served our country. VA loans are a great option because they let you buy a home with 0% down and no private mortgage insurance.

Mortgage Payment

Your mortgage payment is the amount you pay every month toward your mortgage. Each monthly payment has four major parts: principal, interest, taxes and insurance.

Principal

Your loan principal is the amount of money you have left to pay on the loan. For example, if you borrow $200,000 to buy a home and you pay off $10,000, your principal is $190,000. Part of your monthly mortgage payment will automatically go toward paying down your principal. You may also have the option to put extra money toward your loan’s principal by making extra payments; this is a great way to reduce the amount you owe and pay less interest on your loan overall.

Interest

The interest you pay each month is based on your interest rate and loan principal. The money you pay for interest goes directly to your mortgage provider. As your loan matures, you pay less in interest as your principal decreases.

Taxes And Insurance

If your loan has an escrow account, your monthly mortgage payment may also include payments for property taxes and homeowners insurance. Your lender will keep the money for those bills in your escrow account. Then, when your taxes or insurance premiums are due, your lender will pay those bills for you.

Mortgage Term

Your mortgage term refers to how long you’ll make payments on your mortgage. The two most common terms are 30 years and 15 years. A longer term typically means lower monthly payments. A shorter term usually means larger monthly payments but huge interest savings.

Private Mortgage Insurance

Private mortgage insurance is a fee you pay to protect your lender in case you default on your conventional loan. In most cases, you’ll need to pay PMI if your down payment is less than 20%. The cost of PMI can be added to your monthly mortgage payment, covered via a one-time upfront payment at closing or a combination of both. There’s also a lender-paid PMI, in which you pay a slightly higher interest rate on the mortgage instead of paying the monthly fee.

Promissory Note

A promissory note (or mortgage note) is like an IOU that includes all of the guidelines for repayment. It is the written promise or agreement to pay back the loan using the agreed-upon terms. These terms include:
  • Interest rate type (adjustable or fixed)
  • Interest rate percentage
  • Amount of time to pay back the loan (loan term)
  • Amount borrowed to be paid back in full

Once the loan is paid in full, the promissory note is given back to the borrower. If you fail to uphold the responsibilities outlined in the promissory note (i.e. pay back the money you borrowed), the lender can take ownership of the property.

The Mortgage Process

To become a homeowner, you'll need to complete a number of moves.

Get Approved

Before you start shopping at houses, it's a smart idea to get an initial approval from your mortgage lender. Being pre-approved will tell you just how much you'll qualify for, so you don't spend time looking at houses that are out of your price range. The initial approval process is referred to by a number of words by mortgage lenders, including approval, preapproval, and prequalification. It's important to find a lender that verifies the majority of the data up front so you can make a good bid. Only Quicken Loans provides the Verified ApprovalSM1, which verifies your wages, savings, and credit before you apply, giving you the power and assurance of a cash buyer.

Shop For Your Home And Make An Offer

Now comes the exciting part! To begin looking at homes in your city, contact a real estate agent. Professional real estate agents will assist you in finding the perfect house, negotiating the offer, and doing all of the paperwork and details.

Get Final Approval

Once your bid is approved, you'll need to complete a few more steps to complete the deal and secure funding. If all of the particulars of the mortgage weren't checked upfront, the lender can do so now. This includes your wages, jobs, and properties. They'll still need to double-check the property details. This also entails obtaining an assessment to validate the home's valuation and quality. Your lender will also employ a title firm and examine the property's title to ensure that there are no complications that may delay the sale or trigger difficulties later.

Close On Your Loan

You'll consult with your broker and a real estate agent to close the loan and gain possession of the house until it's officially licensed. You'll pay your down payment and closing expenses at closing, as well as sign your mortgage documents.

Summary

A mortgage is a loan that can be used to purchase a house. A loan arrangement is a contract between a lender and a borrower. Knowing the basics of mortgage jargon ahead of time will help you to understand what you're getting into. There are various types of mortgages available, as well as various interest rates. Getting accepted, looking for a home and making a bid, getting final approval, and closing are the most important stages in the home buying process.

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