Whatever your got-to home buying strategy is—a cash buyer or home loan diva—we've put together…
How do mortgages work?
Everybody wants a place they can call home, but buying a home can be very complicated. Finding the right place is tough, but everyone gets anxious when committing to the most significant financial transaction of their life. Don’t worry. In this blog post, we will explain mortgages so you can feel confident when applying for one.
What “mortgage” means
Don’t be concerned if you have a less than stellar credit history. While you might end up with higher interest rates and fees, you can still get approved for a mortgage despite some late payments in your past. One option is to apply for government-backed loans, which may have slightly lower interest rates and more lenient requirements.
A frequently asked question is how high your credit score must qualify for a mortgage; you generally need to aim for 620 or higher. Here is an overview of the major types of mortgages and their requirements.
The 3 Types of Mortgages
Interest Rate-Fixed or Adjustable
The first way of categorizing a mortgage we will discuss lets you decide on the interest rate you pay during your loan term. You can either have a Fixed Rate Mortgage or an Adjustable Rate Mortgage.
As the terminologies imply, a fixed rate means that you will pay the same rate for the entire mortgage. On the other hand, an adjustable rate means that your mortgage’s interest rate will change based on a set index. When the index goes up, your Adjustable Rate Mortgage goes up as well; and when it goes down, your loan’s interest is cheaper.
An adjustable-rate mortgage may be cheaper at the beginning of the loan, and that attracts many people. Fixed-rate loans are more stable and allow you to budget accordingly.
Length of Your Loan-10, 15, or 30 Years
When you apply for a mortgage, you also need to decide how long you want to make monthly payments.
While a long-term loan seems like an attractive option because of the lower monthly payment, it also means that the total amount of interest you pay will be much more significant. Your house’s closing purchase price will end up much cheaper than the total sum of all your monthly payments (principal + interest) by the time you complete your mortgage. As we know, interest can compound over time!
Shorter-term loans can save you thousands with the caveat you have to pay a higher monthly payment. When you make this decision, you’ll have to examine your financial situation: how stable your income stream is and if you have enough money saved in the bank for emergencies.
Finally, you can choose if you prefer to have your mortgage insured by the federal government or not.
As already mentioned, getting approved for a mortgage will depend a lot on your financial capacity. Those who do not have enough money yet to purchase a house outright or for those who will be first-time homeowners can apply for FHA loans. This type of mortgage is handled by the Department of Housing and Urban Development. FHA loans can be easier to use compared to Conventional Loans, which we will discuss later.
The Department of Agriculture makes USDA loans to homeowners who live in remote areas. These loans require an upfront fee that is about 1 percent of the purchase price. The Department also has an official list of lenders that you can check out here.
Service members can take advantage of VA loans via the Department of Veteran Affairs. Service members and their families earn one of the best offerings in mortgages because VA loans do not require down payment or even insurance premiums.
FHA, USDA, and VA loans are all Government-Backed Loans.
On the other hand, Conventional Loans are mortgages that meet the requirements for resale to the Federal National Mortgage Association (also known as Fannie Mae) and Federal Home Loan Mortgage Corporation (or Freddie Mac). They are known as “conforming” loans. These two institutions insure mortgages that they acquire through secondary market lenders.
Conventional Loans aim to buy a home with good credit scores and steady streams of income.
Pros and Cons of Getting a Mortgage
If you’re still unable to decide which option will work best for you, we’ll lay out some of the pros and cons to help you understand.
If you have a mortgage…
- It will bring up your credit score, provided, of course, that you can make monthly payments without skipping any. If you have started with a government-backed loan, for example, and decide to move, you might become eligible for a conventional loan next time.
- You have more liquidity, and as they say, cash is king. The money you don’t lock up in your house provides a financial cushion for life’s surprises.
- Often, with a new house comes the need to make several home improvements. You might need to fix parts of the house or purchase furniture. With a mortgage, you’ll have more flexibility to make these home improvements.
- There are also tax benefits to taking a mortgage. Mortgage interest payments can be tax-deductible, so you will end up paying less in taxes. (We don’t provide tax advice, so please contact a licensed professional to learn more about the tax implications.)
If you don’t need a mortgage…
- You’re fortunate to be able to pay for a cash home!!
- You can be the preferred buyer in a very competitive market.
- You don’t have to worry about payments which can help you bring down monthly expenses.
- No stressing about wooing a lender for a loan, especially if you’re not a fan of the process.
- You can spare yourself the total cost of the mortgage, which can even get up to double the original purchase price of your home.
- There are also several mortgage fees that you are skipping out on, like origination or appraisal fees. It’s just cheaper to pay in cash!
These advantages and disadvantages make a lot of sense if you are privileged enough to have these choices. But for many people, avoiding a mortgage is not an option.
When you apply for a mortgage, the bottom line is it involves a lot of decision-making and financial planning. On the other hand, when you choose to pay in cash and end up with much less money in the bank, this can leave you at risk when you meet unforeseen troubles down the road.
Home buying is an important decision you have to make that can impact your future, so choose wisely! Read up as much as you can or sign up for our platform and let our AI-Powered Mortgage Advisor, Kev, prepare you. He will help you find the right mortgage type for your financial situation, and he even enables you to budget for home repairs.
Your future self will thank you.