There are many different types of mortgages available today, and it's important to determine which best meets your needs before committing to such an important outlay. Before you get to that point, however, you need to learn some fundamentals about mortgages in general. Below are 10 basics to get you started.
1. Your house is the collateral. No matter which type of mortgage you end up using, the basic principle is simple — you're borrowing money to pay off the purchase of your home, and you're paying interest on the loan. Your house and the land it sits on are the collateral against that loan. If someone cannot pay in conjunction with the terms of the contract, the lender can foreclose on your home.
2. Preapproval. Before house hunting, get preapproved by a lender, so you can receive a mortgage once you find the house you want.
3. Mortgage and down payment. A down payment on a house is typically anywhere from five to 20 percent. The down payment precedes the mortgage, which is then the amount borrowed on the remaining cost of the house. Therefore, a $300,000 home, after a 20 percent down payment of $60,000, would require a mortgage of $240,000.
4. Two primary parts. Mortgages are typically divided into two parts — the payment against the amount borrowed, and the interest due on that amount. Real estate tax and property insurance are also generally factored into a mortgage.
5. Lenders. Mortgages can be obtained from a wide variety of sources. It's best to shop around to find the best rates, deal, and a lender you trust. Do your homework.
6. Fixed vs. adjustable. Fixed mortgages lock in an interest rate at the time you purchase the loan. If interest rates are low, this is advantageous. Adjustable rate mortgages (ARMs) change periodically, depending on the terms of the mortgage.
7. Loan term. There are a variety of loan terms, but the most common mortgages are for either 15 or 30 years. The basic rule of thumb is that the shorter the term of the mortgage, the lower the amount of interest you will have to pay. However, monthly payments will then be higher.
8. Tax deductions. The mortgage interest portion of your annual payment can be deducted on your tax returns.
9. Secondary mortgages. Secondary lenders purchase mortgages from lenders, thus allowing lenders to have more money available for other people seeking loans. The secondary lenders do not directly lend you the money, but work as go-betweens linking investors with lenders. Fannie Mae, the largest source of home mortgage funds in the nation, is a secondary lender.
10. Points. By paying additional money up-front, you can secure a lower interest rate on the loan. Each point you pay is a percentage of the mortgage. It's important to calculate whether points will actually be beneficial.
One final note: You should know what you can afford before seeking a mortgage for a home. A rule of thumb suggests that no more than 28 to 33 percent of your gross monthly income should go toward your mortgage payment, including real estate taxes and homeowners insurance.