Mortgages are the most common way that people obtain the money they need to purchase their homes. If you are a first-time home buyer, the following overview can help you understand how mortgages work and what fees you can expect. There are also a few helpful tips for when you apply.
How Do Mortgages Work?
A mortgage is a long-term loan that is usually made by either a bank or credit union specifically to buy real estate. After acquiring a mortgage, a homeowner will then repay the loan in monthly installments over 15 or 30 years.
A down payment is usually required to qualify for a mortgage. The required amount will vary depending on the lender and the type of mortgage you are applying for but it is typically 10% to 20% of the purchase price of the home.
When you obtain a mortgage, you usually do not need any collateral. The home you are buying serves as the collateral.
Related: 15 Year vs. 30 Year Mortgage
It’s important to point out that there are fees involved with obtaining a mortgage. These fees are usually paid at the mortgage closing when the title is legally transferred. Closing costs are usually between 2% and 5% of the loan amount. Just a few things closing costs may cover include:
- Loan origination fees
- Home appraisal
- Home inspection
- Attorney’s fee
- Escrow fee
- Title insurance
- Recording fee
- Title transfer tax
- Other fees and taxes
Some lenders may also require you to obtain private mortgage insurance (PMI). This insurance protects the lender in case of a loan default. Most lenders do not require PMI with down payments of at least 20%.
How Does Interest Work?
When you repay a mortgage, you aren’t just repaying the money you borrowed. Part of your monthly payments is interest, which is a fee you pay for the money you borrow.
The money you pay in interest is usually expressed as a percentage and is known as the interest rate. If you have a mortgage for $300,000 and a 4% interest rate, for example, you will be paying $12,000 in interest for the year or $1,000 per month.
Mortgages can have interest rates that are either fixed or variable. With a fixed rate, the rate is locked in during the loan origination process and your monthly mortgage payments will be the same each month. Many people prefer fixed rates for their simplicity and predictability.
If a mortgage has a variable interest rate, the rate will fluctuate over time. Variable interest rates may be a good choice if you think interest rates will go down in the future.
When shopping for mortgages, you may encounter a term known as the annual percentage rate (APR). The APR includes the interest rate, but it also includes loan fees. The APR is a better representation of the cost of your loan than the interest rate alone.
Great Mortgages for First-Time Home Buyers
First-time home buyers may also be first-time borrowers. There are many items to take into consideration when buying your first home. And there you may qualify for a special home loan that gives you a better interest rate and other features than conventional loans. These loans are offered by banks and credit unions and are backed by government agencies.
Backed by the Federal Housing Administration (FHA), these loans are great for first-time home buyers with low credit scores and small down payments. A minimum credit score of 580 is required, and the down payment can be as little as 3.5%.
To qualify for an FHA loan, you must meet certain requirements. You may also be required to purchase FHA mortgage insurance if your down payment is less than 20%.
It’s possible to finance 100% of a home with one of these loans backed by the U.S. Department of Agriculture (USDA). No down payment is required, and you don’t need a high credit score to qualify. USDA loans are only available for homes in certain rural areas.
VA loans are supported by the U.S. Department of Veterans Affairs (VA) and for active-duty military personnel, veterans, and eligible family members. No down payment is required, and interest rates are often lower than other loans.
Before You Apply
There are several things you can do before you apply for a mortgage to ensure a smooth process. They can also help you identify things you can do to improve your chances of loan approval.
Check Your Credit Report
It’s a good idea to obtain copies of your credit report from each of the three credit bureaus before you apply. If you find an error in one of the reports, you can file a dispute with the reporting bureau and possibly have it removed.
Eliminate or Reduce Existing Debt
Your current debt will be considered when your loan application is evaluated. You can increase your chances of loan approval by reducing existing debt as much as possible. Paying off credit card debt is usually the easiest way to do this.
Avoid Multiple Mortgage Applications
Although it may sound like a good idea to apply for as many mortgages as possible to see which lender will approve you, a hard credit check will be done on each application. Too many hard checks in a short period of time can harm your credit score.
Get Your Documents in Order
Before you apply for a mortgage, contact the lender and find out what documents you will need. If requests for additional documentation are needed after you submit an application, it could slow down the loan approval process.
What Happens After You Apply As a First-Time Home Buyer?
Applying for a mortgage is the first step in becoming a homeowner. Your application will then go through the underwriting process where your work history, credit score, current debts, and other information are carefully evaluated to make sure you can repay the loan.
Wasatch Peaks Credit Union is here to help you every step of the way. Once you’ve made it through the application, we outlined the steps in the mortgage process to help you on your journey to owning a home.