A Complete Mortgage Guide
What is a Mortgage?
A mortgage is a loan that is used to finance the purchase of real estate property. This can include a single-family home, a condominium, a multifamily property such as a duplex, and other types of real estate.
The borrower of a mortgage loan typically has between 15 years and 30 years to pay the loan back, depending on the agreement with the lender.
The borrower typically pays back the loan in a series of installments spread out over that 15- or 30-year period. The payments include the original loan amount, also known as the principal, and interest, which is paid to the bank in exchange for lending the money.
What are the Different Types of Mortgage Loans?
There are several different types of mortgage loans. These are the most common types:
- 30-year fixed rate mortgage. A 30-year fixed rate mortgage has an interest rate that is the same for the entire 30-year period. This is the most popular type of mortgage. It is considered the best mortgage for those who want a low monthly payment.
- 15-year fixed-rate mortgage. Similar to a 30-year, a 15-year fixed rate mortgage has the same interest rate for the entire 15-year period. It typically comes with a higher monthly payment, but a lower interest rate. This is a popular loan for refinancing and for those looking to pay off their mortgage faster.
- Adjustable-rate mortgage. An adjustable-rate mortgage (ARM) has an interest rate that is set for a specific time period. For example, ARMs will typically have an interest rate that is set for the first five to 10 years, and then it adjusts to a new rate after that period is over. This is a good option for someone who doesn’t intend to stay in the same location for very long or rates are high, and they are expected to drop in the future.
- FHA mortgage. An FHA mortgage is backed by the Federal Housing Administration (FHA). FHA loans are intended for those who have a low credit score and a lower down payment.
- VA mortgage. VA mortgages are insured by the U.S. Department of Veterans Affairs, and they are only available to service members and veterans. They do not require a down payment, and they come with a low interest rate.
Understanding Mortgage Interest Rates
The interest rate affects the mortgage payment amount and is a major factor in determining whether a borrower can afford the mortgage.
The lower the interest rate, the lower the monthly payments. This makes finding a lender that can offer the lowest rate while being reliable and trustworthy a top priority for borrowers.
The interest rate depends on both market factors and personal factors.
Personal Factors and Interest Rates
Here are the personal factors that affect interest rates:
- Credit Score. Your credit score tells lenders how much of a risk it is to lend money to you. If you are someone who pays your bills on time and you don’t max out your credit, lenders will see you as low risk. For a conventional loan, you’ll want a credit score of at least 620. If you qualify for an FHA loan or VA loan, your credit score needs to be at least 580.
- Down Payment. Your down payment determines the Loan to Value Ratio, or LTV. If you don’t have any skin in the game, this is another factor that will tell lenders that you are a risky borrower. In order to keep your mortgage rate low, you will want to aim for a down payment that is at least 20 percent. It tells lenders that you are less likely to default on your loan.
- Occupancy. Another personal factor that affects your interest rate is whether or not you are purchasing the property as your primary residence or as an investment property. People are less likely to default on the mortgage for their own home since it’s where they live, and they don’t want to lose their home. For this reason, interest rates tend to be lower for primary residences.
Market Factors and Interest Rates
There are market factors that affect interest rates that are outside of your control.
Here are the market factors that influence interest rates:
- Federal Reserve Board. The Federal Reserve does not directly set the interest rates that consumers see. The Federal Reserve sets the rates that banks are charged to borrow the money to loan to consumers. These rates impact what banks charge consumers. The Federal Reserve will lower or raise rates depending on the needs of the economy. If the economy is struggling, rates will be lowered. If the Federal Reserve needs to slow down the economy, it will tighten up the money supply by raising rates.
- The Bond Market. Mortgage bonds, or mortgage-backed securities, are groups of mortgages that are bundled together and sold in the bond market. When the stock market is underperforming, the demand for mortgage bonds tends to be higher, and interest rates increase. When the demand is low, interest rates tend to be lower.
- Secured Overnight Finance Rate (SOFR). The Secured Overnight Finance Rate, or SOFR, is the rate banks are charged for overnight borrowing. The SOFR is what banks typically use to set a mortgage’s base interest rate.
- Constant Maturity Treasury Rate (CMT Rate). The Constant Maturity Treasury Rate, or CMT, is typically used to determine the interest rate for adjustable-rate mortgages (ARMs). The CMT is based on an average yield of different U.S. Treasury securities.
- The Economy. One market factor that affects interest rates is the economy. Mortgage rates go up when the economy is healthy, meaning there is low unemployment and healthy spending. Interest rates fall when the economy is struggling.
- Inflation. Interest rates also tend to increase when inflation increases. This is necessary so that interest rates match the value of the dollar. Interest rates will also fall when inflation decreases.
The type of mortgage you decide to get will also impact the interest rate. For example. If you choose a 15-year mortgage, your payment will be higher, but interest rates tend to be lower.
If you choose a 30-year mortgage, your interest rates will be higher.
What is Mortgage Refinance?
Mortgage refinancing is when homeowners replace their current mortgage with a different home loan.
Homeowners may decide to refinance a loan if or when interest rates drop, to have a lower monthly payment, or to access equity they’ve built up in their home.
It requires a similar application and underwriting process that a homeowner goes through when he or she first purchased the home.
When Should You Refinance My Mortgage?
Because refinancing can be an arduous process, there should be good reasons for the new loan that make the hassle worth it.
Here are some reasons why you may decide to refinance your home:
- Lower your monthly payment. One reason to refinance your home is to have a lower monthly payment. This may be necessary if your initial loan came with a higher interest rate.
- Access equity. Refinancing your home can also be a chance to access equity you’ve built up in your home. This is done by taking out a loan that is more than the amount that is owed on the home but equal to the current market value of the home. This is known as a “cash-out refinance.”
- Pay off mortgage faster. Some homeowners may want to switch from a 30-year mortgage to a 15-year mortgage so that they can pay it off faster. This typically means larger monthly payments but with a lower interest rate.
- FHA mortgage insurance. For those who took out an FHA loan and who want to get rid of the FHA mortgage insurance premium, the only way to do so is to refinance the mortgage.
- Adjustable-rate mortgage. For those who took out an ARM, and payments went up after the fixed rate period is over, may find themselves wanting to switch to a fixed rate mortgage that doesn’t change.
What is a Home Equity Loan?
If homeowners need a large infusion of cash, but don’t want to refinance their home, they can look at taking out a home equity loan. A home equity loan is a type of second mortgage, as it’s a loan taken out against the equity of the home.
Banks typically won’t allow homeowners to take out less than $35,000.
Home equity loans typically include fixed interest rates, closing costs, processing fees, origination fees, appraisal fees, and other fees.
A home equity loan is paid back in five to 30 years, and it is paid in monthly installments.
What is a Home Equity Line of Credit?
Another type of second mortgage is a Home Equity Line of Credit (HELOC). A HELOC is a good option for those who need extra cash periodically.
The money from a HELOC can typically be accessed through a transfer, a check, or a debit card connected to the account.
Homeowners have ongoing access to the funds, which is typically 10 years and 20 years to pay the loan back. The payments vary.
When the money is paid back, the funds are available again to draw from for the 10-year draw period.
First Time Home Buyer
First time home buyers have several programs they can take advantage of when making that first purchase.
Both the federal government and individual states have their own programs available to first time home buyers.
A First-Time Home Buyer Defined
In order to qualify for first-time home buyer programs, you must meet the following qualifications:
- At least one of the individuals on the mortgage must not have owned a residence in the last three years.
- A single parent or former homemaker who owned a home with a former spouse.
- Someone who owned a residence that did not have a permanent foundation.
- Someone who owned a residence that did not comply with building codes and the cost to bring the property up to code would cost more than building a permanent structure.
If you qualify as a first-time home buyer, these are some of the programs you might be able to participate in:
- Down Payment Assistance Loans. In order to qualify for most mortgages, you need a sizable down payment. Down Payment Assistance (DPA) helps pay for the down payment in the form of a grant or a low or no-interest loan.
- Government-Backed Loans. If you don’t have a down payment, another option is to obtain a government-backed loan that allows first-time home buyers to obtain a mortgage without a down payment.
- Tax Deductions. First-time home buyers may be able to save money on their taxes with several deductions. Some deductions include mortgage insurance costs and interest paid.
- Closing Assistance. Similar to the down payment assistance loans, you may also be able to obtain help paying for closing costs in the form of a grant or low-interest loan.
- Good Neighbor Next Door. If you are a teacher, a firefighter, an emergency medical technician (EMT), or a police officer, you may qualify for the Good Neighbor Next Door program offered by the U.S. Department of Housing and Urban Development (HUD). This program offers a steep discount on HUD properties, which are essentially foreclosures that are more affordable.
- HomePath Ready Buyer Program. The HomePath program is offered by Fannie Mae, and it allows first time home buyers to put 3% down on a foreclosed property.
There may be other programs in individuals states that first-time home buyers may be able to qualify for.