Buying a home for the first time can be one of the most scary — if not financially terrifying — things you can do in life. It’s a process filled with confusing jargon, and even more confusing terms and stipulations, which can cause even the most well-informed first-time homebuyer to be filled with a myriad of mortgage questions.
More pressing are the high financial stakes involved with the purchase of your first home. How do you know what all your mortgage options are? How do you figure out the ins and outs of mortgage financing? And how do you avoid making many of the mortgage lending blunders that plague many first-time homebuyers?
Here’s the scoop on nine of the most common mortgage questions that will help you up your mortgage IQ in no time; your very own first time homebuyer 101, if you will.
Your Mortgage Questions Answered
1. What does “conventional” mortgage mean?
Contrary to popular belief, “conventional” does not refer to the length of a mortgage, or even the interest rate. The term is used to designate a mortgage not secured or insured by the federal government. (An example of a conventional mortgage loan would be one taken out with your local bank.)
A government loan (such as an FHA, VA or USDA loan) is one that is guaranteed by the U.S. government. And can be a fantastic option for those who qualify, such as members of the armed services or first-time homebuyers, because mortgage loans of this type can offer very favorable terms.
2. How much of a mortgage can I afford?
Determining how much house you can purchase varies widely. A good guideline is the “28/36 Rule,” which states, as detailed by Investopedia, a single household should spend no more than 28 percent of its gross monthly income on housing expenses and 36 percent on total debt (including credit cards, auto loans and other forms of debt service).
Here’s how the math breaks down:
- If you make $5,000 a month in gross income
- You would be able to spend $1,400 on housing expense (28%)
- And spend another $400 on debt ($1400 + $400 = $1800 or 36% of your income)
This doesn’t mean, if you meet the above requirements, you’re certain to be able to afford a house, or that a bank is guaranteed to give you mortgage financing; it just means you are in a good qualifying position to take out a mortgage.
3. How do I know if I can get approved for a mortgage?
Your viability for a mortgage loan is determined by many factors. They include:
- Total gross income and debt-to-income ratio (see above)
- Work history (It helps if you’ve been in the same job for at least two years)
- Credit score
- The amount of your down payment
- History of bankruptcies, collections, or late payments
- Maxed-out credit cards
- The condition of the property you intend to purchase
No single factor will determine your loan worthiness. That said, don’t lose faith if your credit profile is less-than-stellar in any one of these areas. It’s worth noting, however, that your overall portfolio of credit indicators reflect trustworthiness in the eyes of the lending institution.
4. Fixed rate or variable interest rate?
This will depend on your particular financial situation. Generally, if you prefer the consistency of a fixed repayment loan amount, over the course of the entire mortgage, you’ll want to go with a fixed rate loan.
If you’d like to take advantage of the lower interest rate in the beginning of a mortgage — for example, investment purposes — then an ARM (adjustable rate mortgage) with a mortgage rate that starts low and rises over time, might be for you. Again, this depends on your situation. There are even mortgage lending institutions that will give you a 10-year or 40-year loan, if you look for them.
The two most common options are:
- 30-Year mortgage – Pros: Lower payments; no prepayment penalties; the ability to put your money into other investments over the course of the loan. Cons: A fair chunk of your mortgage payment will go toward interest (which you can write off).
- 15-Year Mortgage – Pros: Own your house outright in half the time; less interest over time; lower interest rate than a 30-year loan. Cons: Higher monthly payments; less opportunity to “write off” mortgage interest (less tax benefit).
6. How much of a down payment do I need to have?
There’s no hard-fast rule about down payments when it comes to mortgage lending, but one exception: the higher your down payment, the lower your monthly mortgage payment. And yet, generally you’ll need to save somewhere between 5-20% of the total home cost for a 30-year fixed mortgage.
If you’re pursuing a government-backed loan, such as a VA or USDA loan, you can actually purchase a home with no money down (the FHA program for first-time homebuyers requires just a minimum of 3.5% of the total mortgage amount). However, in most cases — aside from the VA loan — the difference between the total amount of your down payment and 20% of the total mortgage must be made up with PMI.
7. What’s PMI?
PMI stands for private mortgage insurance and is simply a monthly premium added to your mortgage in the event you’re purchasing the house with less than 20% down. It’s important to note PMI does not affect the principle of the loan (think of it as a really complicated version of car insurance, but in this case it protects the lender, not the buyer).
Once you’ve paid off at least 20% of your mortgage, or accrued a suitable amount of equity, you can request the PMI be removed by your lender.
8. What are closing costs and how do I avoid them?
Closing costs are the numerous attorney, title insurance, lender and government fees incurred in the creation of a mortgage loan. And they are nearly impossible to avoid entirely.
But there are a couple of ways to reduce closing costs:
- Close near the end of the month: If you close at the beginning of the month, you must pay per diem interest until the end of the month. However, if you close near the end of the month, you’ll reduce your per diem interest cost considerably.
- Try to get the seller to pay: This isn’t always possible, especially in competitive housing markets, but sometimes you can get the seller to cover the cost of closing (don’t worry: they get to write it off as a tax expense).
- Roll closing costs into the loan: Don’t let closing costs force you to step away from a good deal. If the terms of the loan work for you, then wrap those closing costs into the principle of the loan.
9. Where’s the best place to find a mortgage loan?
Short answer: anywhere you can.
Don’t worry about raising alarms with the credit reporting agencies searching for numerous loans at the same time. Running several credit inquiries, within a specific period of time, such as that week or two shopping for mortgage loans, is seen as “one credit inquiry event” and will not hurt your score.
The key is to shop around until you find the best mortgage rate and terms you can. This includes sources such as:
- The government (such as an FHA or VA loan)
- Credit unions
- Insurance companies
- Organizations you belong to
- Mortgage brokers
Going the Extra (Mortgage Loan) Mile
The key to sifting through the many mortgage options out there, and finding the mortgage loan with the terms you desire, is to arm yourself with as much information as you can. Do your homework and assemble a team of professionals who can help you navigate straight to the answers those inevitably confusing mortgage questions formulate.
Do that, and you’ll do more than just alleviate the stress of the mortgage loan process: you’ll set your financial future on some solid (and likely profitable) footing.