A mortgage is arguably the most essential factor in acquiring a home. Average income earners can hardly purchase a home on cash basis, and so the best option is to apply for mortgage. There are a lot of options when it comes to the perfect type of mortgage, but you need to establish your goal. It is important that the buyer understands the terms and conditions of his loan. As a matter of fact it is not as complicated as you might think.
Here are some of the most common mortgage questions, and you may probably have some of these in mind:
1. What is a mortgage?
A mortgage is a loan contract to finance the purchase of a home. A lender enters the contract with the buyer, who agrees to pay interest and other costs on top of the principal loan. The house and the land where it stands automatically become the collateral (or security bond) for your loan. In the event that the buyer fails to keep up with obligations, the lender has the right to take the property and resell it to take care of the debt. This process is called foreclosure. You don’t want to fall into this situation, do you?
For starters, there are two important things you need to ask yourself:
These are valid questions that will help you get started on a mortgage. Lenders don’t meddle with your personal affairs like how and where you are going to spend your money. They will base their approval on the documents you will submit. If you as the buyer declare more than you can afford, the lender will probably give you more. But here’s the catch: Failure to pay may mean losing your home. Therefore, you should know how flexible your funds are.
Upon applying for a mortgage, the lender makes a calculation of your income against debt. They will look into your savings account and credit background. If you have a stellar credit score, chances are you will get approved for a higher loan amount. The lender will take into consideration the face value of the home you wish to purchase and how much interest it will incur. Only then will they arrive at a loan amount that they will grant you. In a typical scenario, your approved loan should equal or surpass the necessary down payment and the cost of the home you intend to purchase.
2. How will I know what type of mortgage to choose?
Choosing a type of mortgage is simple, but it’s really easier said than done. Major decisions like buying a home require thorough analysis. Whether this home will just be a starter home or a place for keeps, the answer to this question will help trim down your options.
3. Will it matter how long I intend to stay in the house?
The answer is a resounding yes! The length of stay will enable you to choose the type of mortgage loan that makes the best sense. It will be a determining factor whether interest rates or points matter more to you.
If you intend to stay in the house for keeps and prefer the stability of fixed monthly payments, you should choose fixed monthly mortgages. This is going to be beneficial for you because you will be able to manage your budget better. As a general rule, fixed monthly mortgage is considered a safer scheme due to the fact that payments remain the same regardless of rate changes in the market. On the flip side, though, this type of mortgage won’t do you good if rates fall dramatically. Fixed monthly mortgages are more expensive than adjustable rate mortgage (ARM) but have greater payment security. Every time you pay your monthly due, your balance decreases because you are paying both the mortgage and interest per month.
If your goal is to keep the house on a temporary basis because you intend to sell it eventually, you should go for ARM. This type of mortgage offers variable interest rate that can change throughout the loan period. This way you can get a lower interest rate for the first five years or so. At the end of this period, ARM will implement a margin plus index. The advantage to the buyer is that as the rates start to increase, you might have sold the house already. But in the event you stay longer in the house, there is a possibility that you can no longer afford the higher mortgage due to the steep interest rates. Additional points may be charged by the lender, with each point equivalent to one percent of your loan amount. You will also be at risk of not getting a refinance.
Nothing in life is really free. You have to choose either the higher rates with lower points, or decreased rates with higher points.
Be advised: Never pay more than 1.5 points to the lender except for reasons such as bad credit, complex loan or purchase of a better interest rate. To further protect your interest, it is best to consult a separate loan specialist who can discuss the effects of discount point on your interest rate.
4. Where can I find today's rates?
Do not be fooled by advertised rates, because they are often misleading. Fortunately, many financial institutions and mortgage companies offer free rate quotes without the need to dig up your personal information. Look for companies that can present you with a list of lenders available in your locality and the latest rates from your local bank for each type of loan.
5. Why are some rates shown as both percentage and APR?
When lenders discuss a particular rate, they should be quoting the annual percentage rate (APR), which includes the interest, points and fees. APR is the amount that you need to pay on top of the principal. It’s best to consult different lending institutions using the same loan amount in order to make the comparison work.
6. What is amortization?
Amortization is a financial scheme in which the buyer or borrower pays the principal amount of debt in installment basis following a specific schedule. As you pay your amortization, the principal decreases until the loan is paid off. These payments are systematically divided depending on the life span of the loan. The first few payments in the beginning cover the interest, while the principal is settled towards the end of the term. All housing loans have a predetermined life – it can be 15, 30 and 50 years based on the qualified criteria of the borrower. This is the timeframe that dictates when the loan will mature. It is crucial that you follow your payment schedule to avoid further penalties and additional interests.
Be advised: Make two separate payments per month – that is, two weeks apart – for a total of 26 payments per year. This payment schedule pours in more payment into the principal and less on the interest.
7. What else should I watch out for?
Prepayment penalty (or “prepay”) is a contract stipulation agreed upon by the lender and the borrower. It describes what the borrower is allowed to pay off and what the corresponding penalty should be, in case the borrower decides to pay off the loan.
Most people think that a prepayment penalty is foolish to consider, and this is especially true for people with bad credit scores. But think about this: Some lenders persuade you to include prepayment penalties in exchange for lower interest rates. In other words, you need to think hard about what you’re going to go for.
8. What is mortgage insurance?
Private mortgage insurance (PMI) is a policy that a borrower must obtain if the down payment is less than 20 percent of the principal value of the house. In such a case, the borrower is going to pay the premium with the lender as the beneficiary. This contract ensures protection for the lender against default borrowers. In cases where the borrower could not fulfill obligations or is no longer paying, the lender is guaranteed to get the payment of the principal amount in full. The insurance premium may vary depending on the face value and the type of loan.
FHA and VA loans are alternative financial sources backed by the government instead of PMI. While VA loans don’t include monthly mortgage insurance, FHA loans do.
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