Before buying a home, it’s important to know what you’re getting yourself into. Mortgages are complex, but crucial to the home-buying process, and as a result, can be quite confusing.
Entire books have been written about mortgages. But who has time to read them, when our time is so overburdened with obligations?
Whether you find time to read a book on mortgages or not, here are five things you absolutely should understand about these loans.
1. What it is
In brief, a mortgage is a loan you take out through a bank or financial institution. The loan guarantees the real estate agent or company you are buying your home through the amount of money that you agreed to pay for the house.
In return, you pay that amount back to the bank or financer within an agreed-upon amount of time. You also agree to pay interest to the bank on top of the loan amount, to make up for any value lost through inflation over the time it takes for you to pay back the original loan.
The institution lending you the money sets the interest rate, whereas you work with the real estate agent and former homeowners to agree on the cost of the home. The loan amount is whatever you owe beyond the down payment you put up yourself.
2. Why you need it
No matter how much money they make, most people can’t afford to drop $200,000 cash on a home. Even if you have the money to do so, it may not be a smart financial decision.
It’s better to keep all that money and save or invest it. After all, there’s no telling what the future holds: $100,000 in saved cash will do more good during unemployment, a serious illness, or when you have children or retire than it will be invested in your home when or if any of those events arise.
Mortgages are also cheap loans that could give you tax benefits, depending on your financial situation—if you are able to itemize your tax return, for example. Plus, you can use mortgage equity to help pay for maintenance and repairs that will raise your home’s value.
3. How long it lasts
Most mortgage loans are for 30- or 15-year terms. A 15-year mortgage typically carries a lower interest rate than a 30-year mortgage, however, the shorter-term assumes you put much more money down on the loan earlier than for a longer-term loan.
Adding a second mortgage—a mortgage loan that pays off your initial loan to give you extra cash, say for emergency repairs—increases the amount of time it will take to pay off the mortgage. If you have a 30-year mortgage loan and take a second mortgage after 10 years, you increase the total amount of time you spend paying on the home to 40 years.
4. What factors affect it
The amount and length of the mortgage loan depend on many factors, including the real estate agent, the home you plan to buy, and the financier who will lend you the money for the mortgage. There are also some factors you can control which affect the loan.
Your employment history, income level, credit score, and financial assets all influence the loan. If you are strong on all fronts, you are more likely to get a lower interest rate.
5. Why it might change
That’s right—there are elements of this loan that could fluctuate. Mortgage interest rates are not fixed, which means that they go up or down depending on the stock market and the local, regional, national, and global financial environment.
You can “lock in” your mortgage rate if you think it is a reasonable rate that you are comfortable paying for 15 or 30 years. You can also have a floating rate that follows the stock market.
Mortgages with floating rates can still be locked in: you can watch the rates and lock in for a fee when the rates are as low as you think they will go. Some lenders also let you lock-in, and then lock in again at a lower rate as the market changes—for a fee, of course.
This is just the tip of the iceberg when it comes to these tricky loans. Each individual lender has its own terms and conditions, interest rates could change throughout the course of a day, and external factors such as Home Owners’ Associations or mortgage programs can influence the cost to which you end up agreeing.
Continuing to educate yourself about the mortgage approval process—and the overall home-buying process—will help you ensure you don’t end up biting off more than you thought you could chew.