How Does a Mortgage Work?
Updated: Jul 2, 2020
Buying a house can be pretty overwhelming so it’s good to have a thorough explanation of the ins and outs of what to expect before signing on the dotted line. Even if you already own your home and want to refinance, there’s a baseline of knowledge that will add confidence to your decision – often one of the biggest you’ll make as an adult.
Understanding up front how mortgages work can eliminate much of the anxiety when navigating big financial transactions – especially these days. Let’s begin with a little bit of history…
The mortgage contract was created by the government in 1934 to help Americans survive and thrive after The Great Depression. Prior to that, it was common to require a 50% down payment to purchase a house, putting ownership out of reach for millions. The new program allowed people to borrow more with less down. Today, 20% is the optimal down payment but it can be much less than that, based on factors we’ll get into shortly.
What Kind of Mortgage Products Are There?
There are several types of mortgages including Conventional, FHA, and VA as well as Refinance options such as term, cash-out and home improvement: • Conventional loans are offered through banks and private mortgage lenders and are not funded or backed by the U.S. government. Although similar guidelines are followed, there is more flexibility on down, interest rates, and home types allowed.
• FHA mortgages are provided through the Federal Housing Administration, typically for first-time buyers who have less to put down and possible credit constraints.
• The Veterans Administration offers VA financing for active and former military personnel, sometimes requiring as little as zero down. • Refinancing a mortgage is replacing your original loan with a new one, often to take advantage of lower interest rates, a home’s growing equity or a change of term. A cash-out refinance is just that: taking the difference of the home’s value and the new loan in cash. Refinancing programs can be conventional as well as through the FHA or VA.
How Does a Mortgage Work?
When entering into a mortgage agreement with your lender, you commit to making a monthly payment that’s constructed of four main components: principal, interest, taxes and insurance – or PITI.
• The principal is the amount of money you borrow remaining after your down payment.
• There are two aspects of interest on mortgage loans; simple and APR, or annual percentage
rate. The APR is interest with fees or costs added in. Most mortgages are simple with the interest applied more at the beginning of the term, then shifting to the balance of the principal; this is amortization.
• Property taxes can be paid directly by the borrower to the county, or through the mortgage by being placed in escrow and rolled into the monthly payment.
• Homeowner’s insurance can also be included in the loan payment. The other insurance that may come into play is PMI – or private mortgage insurance. This is typically added to the loan when a down payment is lower than 20% to mitigate risk. When a lower interest rate or increased equity merits it, refinancing to eliminate the PMI can significantly reduce the monthly payment and save money.
Not included in the PITI acronym, but always a consideration is the term – or length – of the mortgage and whether it’s fixed or adjustable. While a 30-year fixed rate loan is the most popular, most lenders also offer conventional 10-, 15-, and 20-year terms. Adjustable rate mortgages (ARMs) are shorter terms – 3, 5, 7 and 10 – and are based on the current rates. Those rates and current market stability, as well as your purchase or refinancing goals, can all determine which program is the best one for you.
How Do You Receive Mortgage Approval?
While it’s much easier to buy or refinance a home now than it was before the National Housing Act of 1934, there are still requisites needed to get that coveted stamp of approval from a bank or private lender.
As we mentioned, your down payment will help determine your interest rate and which mortgage program is the right choice. While 20% down will snag the best rates and eliminate PMI, there are financing options as low as 3% for both conventional and government funded loans.
A credit report will be pulled to determine your FICO score and eligibility. A score of 650 to 700 is considered fair, but lower credit ratings are not automatically disqualifying.
Proof of income will be requested, whether through tax returns, W2s or 1099s. A stable job is a plus but self-employment does not preclude you from qualifying with many lenders, including EnTrust Funding (ETF).
Where Do You Get a Mortgage?
Whether purchasing your first home or refinancing your existing mortgage, experts always encourage borrowers to shop around. Many lenders have diverse financial products and programs, and can offer competitive rates. EnTrust Funding also brings a crucial comprehension of the current crisis and its impact on your mortgage decisions. Give us a call today for a no-obligation discussion of your financing goals and qualification. Stay safe and healthy.