First Time Home Buyer Financing: Guide to Mortgage Types and Terms
Are you a first-time homebuyer feeling overwhelmed by the multitude of mortgage options out there? Don't worry; you're not alone! Understanding the world of home financing can be daunting, but with the right knowledge, you can navigate it with confidence and skill. Let's break down some mortgage types and demystify some of the terms and concepts of home mortgages to help you make informed decisions about your future. In this guide, you’ll find helpful information on: mortgage types, mortgage terms, mortgage comparisons, mortgage preapproval, and choosing the type of mortgage that is right for you.
Glossary of Mortgage Terms
To make sense of the mortgage jargon, it's essential to familiarize yourself with the key terms you'll encounter during the home buying process. Here's a comprehensive glossary to get you started:
Adjustable Rate
An interest rate that changes periodically in relation to market fluctuations. Payments may increase or decrease accordingly.
Amortization
A repayment method in which the amount you borrow is repaid gradually though regular monthly payments of principal interest. During the first few years, most of each payment is applied toward the interest owed. During the final years of the loan, payment amounts are applied almost exclusively to the remaining principal.
Annual Percentage Rate
The cost credit on a yearly basis, expressed as a percentage. Required to be disclosed by the lender under the federal Truth in Lending Act, Regulation Z. Includes upfront costs paid to obtain the loan, and is, therefore, usually a higher amount than the interest rate stipulated in the mortgage note. Does not include title insurance, appraisal, and credit report.
Application
An initial statement of personal and financial information which is required to approve your loan.
Application Fee
Fees that are paid upon application. An application fee may frequently include charges for property appraisal ($800.00 - $1200.00) and a credit report ($150.00 - $350.00).
Appraisal
A fee charged by an appraiser to render an opinion of market value as of a specific date. Required by most lenders to obtain a loan. ($800.00 - $1200.00)
Assumption of Mortgage
The agreement of a purchaser to become primarily liable for the payments on a mortgage loan. Unless otherwise specified by the lender, the seller may remain secondary liable for payments.
Balloon Payment
A lump sum payment for the unpaid balance of the loan.
Cap
The maximum allowable increase, for either payment or interest rate, for a specified amount of time on an adjustable rate mortgage.
Ceiling
The maximum allowable interest rate over the life of the loan of an adjustable mortgage rate.
Closing Costs
Any fees paid by the borrowers or sellers firing the closing of the mortgage loan. This normally includes an origination fee, discount points, attorney’s fees, title insurance, survey and items which must be prepaid, such as taxes and insurance escrow payments.
Contract of Sale or Purchase and Sale
The agreement between the buyer and seller on the purchase price, terms, and conditions necessary to both parties to convey the title to the buyer.
Credit Limit
The maximum amount that you can borrow under the home equity plan.
Debt Service
The total amount of credit card, auto, mortgage or other debt upon which you must pay.
Deed of Trust
Used in many western states, the agreement used to pledge your home or other real estate as security for a loan. Similar to a mortgage.
Discount Points (points)
The amount paid either to maintain or lower the interest rate charged. Each point is equal to one percent (1%) of the loan amount (i.e. two points on a $100,000 loan would equal $2,000).
Down Payment
The difference between the purchase price and that portion of the purchase price being financed. Most lenders require the down payment to be paid from the buyer’s own funds. Gifts from related parties are sometimes acceptable, and must be disclosed to the lender.
Due on Sale
A clause in a mortgage agreement providing that, if the mortgagor (The borrower) sells, transfers, or in some instances encumbers the property, the mortgagee (the lender) has the right to demand the outstanding balance in full.
Effective Interest Rate
The cost of credit on a yearly basis expressed in the percentage. Includes up-front costs paid to obtain the loan, and is, therefore, usually a higher amount than the interest rate stipulated in the mortgage note. Useful in comparing loan programs with different rates and points.
Encumbrance
A claim against a property by another party which usually affects the ability to transfer ownership of the property.
Equity
The difference between the fair market value of your home and your outstanding mortgage balance.
First Mortgage
A mortgage which is in first lien position, taking priority over all other liens (which are financial encumbrances )
Fixed Rate
An interest rate or monthly payments which is fixed for the term of the loan.
FHA Loan
More appropriately termed “FHA Insured Loan”. A loan for which the Federal Housing Administration insures the lender against losses the lender may incur due to your default.
Grace Period
A period of time during which the loan payment may be paid after its due date but not incur a late penalty. Such late payments may be reported on your credit report.
Gross Income
For qualifying purposes, the income of the borrower before taxes or expenses are deducted.
Home Equity Credit Line
A loan providing you with the ability to borrow funds at the time and in the amount you choose, up to a maximum credit limit for which you have qualified. Repayment is secured by the equity in your home. Simple interest (interest only payments on the outstanding balance) is usually tax deductible. Often used for home improvements, such as major purchases or expenses, and debt consolidation.
Home Equity Loan
A fixed or adjustable rate loan obtained for a variety of purposes, secured by the equity in your home. Interest paid is usually tax-deductible. Often used for home improvement or freeing of equity for investment in other real estate or investment. Recommended by many to replace or substitute for consumer loans whose interest is not tax deductible, such as auto or boat loans, credit card debt, medical debt, and education loans.
Hazard Insurance
A contract between purchaser and an insurer, to compensate the insured for loss of property due to hazards (fire, hail damage, etc.) for a premium.
Index
A number, usually a percentage, upon which future interest rates for adjustable rate mortgages are based. Common indexes include the Cost of Funds for the Eleventh Federal District of banks or the average rate of a one year Government Treasury Security.
Interest Rate
The periodic charge, expressed as a percentage, for use of credit.
Jumbo Loan
Mortgage loans over $806,500.00. Terms and underwriting requirements may vary from conforming loans.
Loan to Value Ratio (LTV)
A ratio determined by dividing the sales price or appraised value into the loan amount, expressed as a percentage. For example, with a sales price of $100,000 and a mortgage loan of $80,000, your loan to value ratio would be 80%. Loans with an LTV over 80% may require Private Mortgage Insurance, defined below.
Lock or Lock In
A commitment you obtain from a lender assuring you a particular interest rate or feature for a definite time period. Provides protection should interest rates rise between the time you apply for a loan, acquire loan approval, and, subsequently, close the loan and receive funds you have borrowed.
Margin
An amount, usually a percentage, which is added to the index to determine the interest rate for adjustable rate mortgages.
Minimum Payment
The minimum amount that you must pay, usually monthly, on a home equity loan or line of credit. In some plans, the minimum payment may be “interest only”, (simple interest). In other plans, the minimum payment may include principal and interest (amortized).
Mortgage Broker
An individual or company that brings borrowers and lenders together for the purpose of loan origination.
Mortgagee
The lender.
Mortgagor
The borrower or homeowner.
Negative Amortization
Occurs when your monthly payments are not large enough to pay all the interest due on the loan. This unpaid interest is added to the unpaid balance of the loan. The danger of negative amortization is that the homebuyer ends up owing more than the original amount of the loan.
Origination Fee
The charge for originating a loan; is usually calculated in the form of points.
PMI
Private Mortgage Insurance. Insurance written by a private company protecting the mortgage lender against loss occasioned by a mortgage default, usually required when the loan amount exceeds 80% of the value of the property.
Points
Each point is equal to one percent (1%) of the loan amount (i.e. two points on a $100,000 mortgage would equal $2,000).
Prepayment Penalty
A fee charged to a borrower who pays off a loan before it is due.
Pre-Qualification
A lender’s initial, unverified determination of the amount of mortgage you may be able to afford. Documentation and verification are not as extensive as for a pre-approved mortgage.
Principal
The amount of money borrowed to buy your home or the amount of the loan that has not been paid off. This does not include the interest you will pay to borrow that money. The principal balance (the amount of money you still owe) decreases with each mortgage payment.
Qualifying Ratios
Calculations used to determine if a borrower can qualify for a mortgage. They consist of two separate calculations: a housing expense as a percent of income ratio and total debt obligations as a percent of income ratio.
Recording Fees
Charges for recording a deed with the appropriate government agency.
Refinancing
Paying off one loan by obtaining another; refinancing is generally done to secure better loan terms (like a lower interest rate).
Second Mortgage
A mortgage made subsequent to another mortgage and subordinate to the first one. A second mortgage may also be referred to as a home equity loan.
Settlement Statement
A form utilized at loan closing to itemize the costs associated with purchasing the home. Used universally by mandate of HUD, the Department of Housing and Urban Development.
Survey Fee
Charge for a survey of the property to confirm the location of buildings and improvements and boundaries.
Tax Service Fee
Charges for service that monitors property tax payments on the property.
Term
The period of time between the beginning loan date and the maturity date.
Title Insurance
Insurance that protects the lender (lender’s policy) or the buyer (owner’s policy) against loss arising from disputes over ownership of a property.
Title Search
A check of the title records to ensure that the seller is the legal owner of the property and that there are no liens or other claims outstanding.
Transfer Tax
State or local tax payable when title passes from one owner to another.
Truth-In-Lending
A federal law that requires lenders to fully disclose, in writing, the terms and conditions of a mortgage, including the annual percentage rate (APR) and other charges.
Underwriting
The process of evaluating a loan application to determine the risk involved for the lender. Underwriting involves an analysis of the borrower’s creditworthiness and the quality of the property itself.
VA Loan
A loan guaranteed by the Veterans Administration, open to veterans, active duty military personnel, and in some cases, spouses of deceased veterans.
Variable Rate
An interest rate that changes periodically in relation to an index. Payments may increase or decrease accordingly.
This glossary of terms should help you navigate the often confusing process of obtaining a mortgage loan. Remember, don’t be afraid to ask questions if you don’t understand any of the terminology. It’s your home and your money.
Choosing a Mortgage
Now that you're equipped with the necessary knowledge, let's discuss how to choose the right mortgage for your needs. Although there are hundreds of different mortgage programs available, they all fall into a few basic varieties. By understanding the differences between mortgage programs, and narrowing your choices accordingly, the process of picking the right mortgage for you becomes much easier.
Fixed Rate vs Adjustable Rate Mortgages (ARMs)
One of your first decisions should be between a fixed rate (the interest rate remains constant through the life of the mortgage) or an Adjustable Rate Mortgage (ARM) (the interest rate is adjusted--either up or down--at specified times during the mortgage term). ARMs will have an initial interest rate lower than fixed rates, but will adjust upward (unless rates really fall!) usually after the first year. They may be a good choice if you are sure that you will not be owning the home for an extended period (more than 5-7 years) of time.
Mortgage Terms: 15, 20 or 30 years
You will probably want to shoot for the shortest term that is comfortable (and for which you will qualify). The interest savings are enormous as the term decreases. Always make a comparison between a 15 year term payment and a 30 year term payment. The difference is often surprisingly smaller than anticipated. The savings over the term of the loan, however, can be substantial.
Mortgage Types
Explore conventional, FHA, VA, and "no-document" loans to determine which best suits your financial situation and homeownership goals.
Conventional Loans
A "traditional" mortgage, (which is not directly insured by the Federal Government), is a conventional loan, usually under $546,250.00, and is administered through Fannie Mae or Freddie Mac (private corporations but regulated by the government). Loans over that amount are designated "jumbo loans" and are funded by the private investment market.
FHA Loans
Insured by (but not funded by) the Federal Housing Administration (FHA) a division of the U.S. Department of Housing and Urban Development (HUD), and designed for low- and middle-income borrowers and many first-time buyers. There are limits to FHA Loans, (which vary from county to county), to the maximum loan amount. FHA loans have somewhat more relaxed qualifying standards than conventional loans and have the availability of both 15 and 30 year fixed as well as 1 year adjustable mortgages.
VA Loans
For those qualified by military service, the Veterans Administration (VA) insures (but does not fund) 15 and 30 year fixed as well as 1 year adjustable mortgages with lower down payment requirements (as low as 0 down) and somewhat more lenient qualifying ratios.
No-Document ("No-doc) Loans
A No-Document ("No-doc") Loan is a type of mortgage that doesn't require borrowers to provide extensive documentation of their income, assets, or employment history. Instead, lenders rely on the borrower's credit score and the property's value to determine eligibility. These loans are typically offered to self-employed individuals or those with non-traditional sources of income who may have difficulty providing traditional documentation. However, they often come with higher interest rates and stricter terms to mitigate the lender's risk. No-doc mortgages are generally not available to borrowers in Washington.
Mortgage Prequalification and Preapproval
Before embarking on your home search, obtaining prequalification and preapproval for a mortgage is crucial. Why get prequalified and then preapproved for a mortgage before you begin your search for a home? Because there are 3 people who will benefit from your preapproval: You, your agent, and the seller of your future home!
Benefits of Preapproval
Preapproval provides clarity on your financial capabilities, enabling you to shop within your budget and strengthen your bargaining position when making offers. All three parties in your real estate transaction benefit from your loan preapproval.
Preapproval benefits for you:
The most important beneficiary, of course, is you. One of the most common questions we get from users of this site goes something along the lines of "Please let us know how much house we can afford." We're stumped! Why? There are simply too many variables—credit history, income, debt, special mortgage programs and variations in qualifying guidelines between different mortgage types—to answer that question. The only sure way of getting the question answered is through prequalification. The mortgage prequalification step is a relatively simple one, but it is an important one. It begins the process of formally applying for a mortgage, and it gives everyone involved--especially you--a clear sense of the direction they should be headed.
Preapproval benefits for your agent:
With a clear understanding of your financial parameters, your agent can devote more time to finding homes that align with your budget and preferences instead of chasing after properties that may be out of reach. Remember, when it comes to mortgages, it's essential to have clarity on your price qualifications and realistic expectations, and preapproval helps streamline the entire home buying process for both you and your agent.
Preapproval benefits for the seller:
Want to strengthen your bargaining position? Get prequalified. Want your offer to stand out in a case of multiple offers for the same house? Get prequalified. Look at it from the seller's perspective. If you had two offers on the table for your house, one from a fully prequalified buyer and the other from an "I'll get around to that soon" buyer, to which offer would you devote the most attention? Even if the prequalified buyer's offer was $1000 less, would you take the chance on the buyer that perhaps may not be qualified?
Remember, the maximum mortgage amount you qualify for isn't necessarily the amount you should borrow. It's essential to consider your financial comfort level and avoid overextending yourself.. For example, if you qualify for a $400,000 mortgage and you have $15,000 available in cash for downpayment and closing costs, you are qualified to buy homes with a maximum selling price of $415,000. So as to not push yourself to the limit, you may want to look at homes that sell in the $400,000 to $410,000 range. Too many buyers simply rush off to the $415,000 level and some find themselves strapped when it comes time to purchase necessary household items (such as draperies, additional furniture and lawn and garden tools, for example) or when they forget to factor in increases in monthly expenses (for example utilities and maintenance and repair costs).
Get prequalified today
Conclusion
Navigating the world of first-time homebuyer financing doesn't have to be overwhelming. By familiarizing yourself with mortgage types, terms, and the preapproval process, you can confidently embark on your homeownership journey. Don't hesitate to ask questions and seek guidance from professionals along the way. With the right knowledge and support, you'll soon find yourself unlocking the door to your dream home.
If you’d like personalized assistance with your home financing journey, contact us here at St. Julien Home Loans.