All About Mortgages
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Types of Mortgages
With a fixed-rate mortgage, the interest rate remains the same for the life of the loan. An adjustable-rate mortgage (ARM) typically begins with a fixed-rate period, and then the interest rate can vary based on the economy and other factors. (A 7/1 ARM, for example, has a fixed interest rate for the first seven years. After that, the rate can adjust once every year for the remaining life of the loan. The Federal Reserve cautions that “If lenders or brokers quote the initial rate and payment on a loan, ask them for the annual percentage rate (APR). If the APR is significantly higher than the initial rate, then it is likely that your rate and payments will be a lot higher when the loan adjusts, even if general interest rates remain the same.”) With an interest-only mortgage, the borrower pays just the interest for a certain period of the loan term, and then starts paying the principal and interest back. Monthly payments usually start low and end up significantly higher. Conventional loans. The government does not insure conventional loans. That might sound scary, but in fact, conventional loans are the most common kind of mortgage. Because conventional loans are not insured by a government agency, they carry more risk for lenders and tend to have stricter eligibility requirements. Government-insured loans. Even if the borrower defaults, the lender won’t lose any money. Government home loans can come directly from the government or private lenders, though not all lenders offer each type of loan. Because of the government backing, these loans can be easier to qualify for and sometimes have lower interest rates or more lenient terms than conventional loans. A 30-year fixed-rate mortgage is the most popular choice because a longer term equates to lower monthly payments. In the long run, the borrower often pays more interest than with a shorter-term loan, but lower monthly payments make housing more affordable and typically easier to qualify for. A 15-year mortgage can be paid off in half the time of a 30-year mortgage. This means less interest paid over the life of the loan and ultimately owning a home faster, but the shorter term will mean higher monthly payments, which can be challenging for some buyers. Many lenders offer 10-year and 20-year home loans, and even some customized loan terms.
Getting a Mortgage
Prequalification. Early in the home shopping process, many buyers elect to get prequalified from a lender. Prequalification is considered a “soft credit” inquiry, when the borrower shares some financial information. Then the lender provides a general idea of how much applicants could borrow and on what terms. Preapproval. Mortgage preapproval means a lender has approved borrowers for a loan up to a certain amount at a specific interest rate based on their financial history. Applicants have to provide more personal information and financial documentation than with prequalification, but it can give them more concrete terms for a mortgage. And a preapproval letter can signal that a buyer is serious about purchasing a home shortly.
Elements of a Mortgage
Principal. The principal is the outstanding total of the loan. A portion of the mortgage will go toward the balance owed in the loan each month. The position that goes to principal each month will vary. Interest. The amount of interest paid on a mortgage each month will vary based on the loan’s amortization schedule. Generally, the amount of the monthly mortgage payment that goes toward interest will decrease over the life of the loan, as more of the payment goes toward the principal. Taxes. If the terms of a borrower’s mortgage include escrow, the lender will break down estimated annual property taxes into monthly payments. The lender disburses the payment when taxes are due. Insurance. Most lenders require the borrower to have insurance on their property. Like taxes, the lender collects the property insurance premium monthly and pays the homeowner’s policy annually through the escrow account. Private mortgage insurance. If buyers make a down payment of less than 20%, they may also need private mortgage insurance, commonly called PMI.
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