How often do you buy a house? Not very often if you’re the typical American. Let’s say you own three houses in your lifetime: your starter home, the one you purchase to accommodate your growing family, and your empty-nester home. That’s a long time between purchases to remember all the ins and outs of getting a mortgage. Who can remember all those details?
Most people don't remember what they had for breakfast yesterday!
Let’s go over the basics of what a mortgage is, the different types there are, and some common terms you’ll need to know.
Like a car loan, your mortgage is based on collateral — the home itself. If you don’t pay your mortgage, your lender has the right to take it and sell it to cover the debt. This unfortunate occurrence is known as foreclosure and you don’t ever want it to happen to you! It's just one of the reasons why it’s important to have a solid and thorough understanding of your mortgage.
The first thing you need to know is that there are several different types of mortgages. Here are three of the most common:
- Fixed Rate. The interest rate and term (10 to 40 years) never change with a fixed rate mortgage. Your monthly payment will be the same for the life of the loan. This is great if you like to live within a strict budget.
- Adjustable Rate. This is also referred to as ARM. The interest rate that only remains the same for a set period of time, such as one, three or five years. After that time, the rate can go up or down, depending on the market. This means your payment may get smaller or larger. Sometimes it’s smart to get an ARM — say if you’re only going to be in your house for a short time — because the initial interest rate may be lower than that for a fixed rate mortgage.
- VA Loan. This loan is available for active military, veterans, and surviving spouses. No down payment is required nor do you have to pay for Private Mortgage Insurance, or PMI. You still have to meet both VA and lender requirements, including having a credit score of at least 620. If you default on the loan, the VA will cover a portion it.
The important thing to remember when applying for a mortgage is to go with the shortest term you can afford. Your monthly payments will be higher, but you’ll save a lot in interest. (See chart below to see how much money you can save!)
Now, let’s look at your monthly mortgage payment. In most cases it will consist of three parts:
- Principal and Interest. The principal is the amount of money you borrowed. If you’re buying a $400,000 house and you put down 20% or $80,000, you’re borrowing $320,000 to purchase the home. This represents the principal. Interest is what your lender charges you to borrow the money. Let's say your interest rate is 3.877% for a 30-year loan and 3.222% for a 15-year loan. Using this handy calculator, here’s what your payments (just including principal and interest) might look like:
|
Loan Amount |
Interest Rate |
Term |
Monthly Payment (Principal + Interest only) |
Total Interest Paid |
|
$320,000 |
3.877% |
30 yrs. |
$1,505 |
$221,847 |
|
|
3.222% |
15 yrs. |
$2,244 |
$83,954 |
- Insurance. You can’t get a mortgage if you don’t have home insurance, which protects your home against fire, theft, bad weather, etc. You must purchase home insurance before you close on your house and show proof that you’ve done so at your closing. The annual premium will be divided by 12 months and added to your monthly payment. Also, if you aren’t able to afford a 20% down payment, you’ll also have to pay for Private Mortgage Insurance (PMI), which protects you against defaulting on your mortgage.
- Property taxes. How much these will be depends on where you live — the state, county and neighborhood — as each sets their own rates. You pay every month, but the money is put in an escrow account so it’s there when your property taxes come due.
So there you have it. Of course, there’s a lot more to learn about mortgages. If you have more questions and would like to speak with someone for answers, we can help. Stop by any of our branches to chat with our experts or use online access to a mortgage specialist.
Hanscom Federal Credit Union published a guide for first-time homebuyers. Download your copy for an easy-to-understand explanation of the mortgage process.
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