Making the decision to purchase a home is equally exciting and daunting. With a median home price of just under $500,000 in the United States, few people can meet the cost to purchase a home up front. This is where mortgage loans come into play. While most people have heard the term “mortgage” before, they may have a limited understanding of what it actually is and what it means.
By learning everything there is to know about a mortgage, you can make an informed borrowing decision the next time you choose to purchase a home.
What is a Mortgage?
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A mortgage is an agreement between a lender and a borrower, where the lender provides you with a sum of money that is to be used for making a home purchase. In return, the lender has a legal right to take ownership of that property if you fail to repay the entire sum of the loan during the agreed upon terms.
Mortgage lenders are most commonly banking institutions, but there are a number of alternative lenders who also specialize in mortgages. From a high-level standpoint, most mortgages will include the following items:
- The principal or sum amount
- The interest rate of the loan
- Closing costs
- An annual percentage rate (APR)
- The length of the loan
To secure a mortgage loan, most experts recommend a credit score of at least 620 to have the best shot at approval. A higher credit score may result in a more favorable interest rate, but credit scores aren’t the only factors lenders consider in their decision-making process.
How Does a Mortgage Differ from Other Loans?
First and foremost, a mortgage is a secured loan, meaning it has some form of collateral attached. In the case of a mortgage, that collateral is the home you are wishing to purchase. Secured loans can use a variety of different types of collateral, with auto loans being another common example. In an auto loan, however, the collateral being put up is the vehicle a borrower wishes to purchase, rather than a home.
Going further, mortgages have far higher borrowing amounts than most other types of loans due to the price of a home. While personal loans typically only have borrowing amounts ranging from $1,000-$100,000, a mortgage loan will go into the multi-hundreds of thousands, if not millions. Given this higher value, borrowers also have longer to repay a mortgage compared to other loans.
The Terminology of a Mortgage
If you see waterfront houses for sale in Winthrop MA that you just have to have, but you have no understanding of how a mortgage actually works, it’s not likely that you will be successful in your purchase. Below are the common terms of a mortgage that a borrower will see and what they actually mean:
The tenor of a loan is the length of time a borrower has to repay the loan, including all interest. On average, mortgages will have a tenor of around 30 years, though this can be shorter or longer depending on specific circumstances.
2. Interest Rate
An interest rate is the rate you are being charged on top of the principal amount. Interest rates can be fixed or variable, but most mortgage lenders offer fixed interest rates. The portion of your interest that is due will be roped into your monthly payment along with the amount of the principal that is due for that month.
3. Annual Percentage Rate
Similar to an interest rate, the Annual Percentage Rate (APR) is a percentage you are charged. However, your APR includes your interest rate and any fees that may exist on top of it. Closing costs, discount points, origination fees, and more are all items that could be included.
The principal of a mortgage loan is the amount that is being borrowed. For example, if you have a $1,000,000 where you can only afford to put $100,000 down, the principal of your loan may be around $900,000.
Most lenders require borrowers to set up an escrow account when they take out a mortgage loan. A portion of your monthly payment is deposited into this account and the funds are used to pay property taxes and insurance costs on that home.
Factors Taken into Account by Lenders When Applying for a Mortgage
When taking out a mortgage, there are a number of factors that lenders will consider to determine if you are a risky borrower or not. Below are four of the most common considerations:
1. Credit score
As mentioned, your credit score will play a major role in whether you are approved for a loan. Generally, lenders want to see a credit score of at least 620 to show you have a decent history with credit.
2. Credit history
Lenders will also look at your overall history with credit in order to see if you defaulted on any loans in the past or if you are overdue on a number of debt payments.
3. Debt-to-income ratio
Your debt-to-income ratio reflects the amount of debt you have compared to the amount of revenue you make on a monthly basis. Generally speaking, lenders want to see that you have far more in income than you own in debt, as it indicates that you are more likely to meet payments.
4. Income level
Finally, lenders will look at your total income level to see if you can afford the monthly payments that would come with a loan.
Purchase your first home today
There’s no doubt that purchasing a home, even if it’s not your first time, is a nerve-wracking experience. You may think you have the best offer on the table, but you never know if someone will come in and beat you out.
However, getting the call that the home is yours makes all of the nerves worth it. By ensuring you have a strong mortgage loan in place from an accredited lender, you can rest easy knowing that you’ll have a place to live for years to come.