With a term of anywhere between 10 and 50 years, a mortgage is the largest single financial transaction most people perform in their lifetime. With so much money (and time) on the line, it’s crucial that you do your due diligence. So before you sign on the dotted line, do your research! Here are a few things you need to know about home loans.
There are two parties in a mortgage: the mortgagor, or borrower (you), and the mortgagee, or lender (typically your bank or credit union). A mortgage is technically a lien, with your home as the lender’s security on your debt. That means that the lender has the right to repossess or foreclose upon it if it becomes clear that you are unable to keep up with payments or eventually repay the principal, which is the original size of the loan. Interest is the mortgagee’s fee for using its funds.
The Types of Loans
There are a few different ways for lenders to charge interest: fixed-rate, adjustable-rate, and interest-only. A fixed-rate mortgage is self-explanatory: The terms you sign up for will not change for the duration of the loan. Adjustable-rate mortgages might initially present a lower introductory interest rate but, as the name implies, the rate is subject to change based on a predetermined index of national interest rates. As your rates change, so do your monthly payments. The Consumer Financial Protection Bureau recommends you calculate your payment based on your lender’s maximum rates (if available) to ensure you can afford the loan, even under extreme circumstances, before accepting it. Interest-only loans are unqualified mortgages that start out with fixed interest rates. The homeowner is not required to pay on the principal of the loan until the 10-year mark, which functions on the assumption that their income will increase over time to accommodate the larger payments.
‘Good’ vs ‘Bad’ Interest Rates
Interest rates can change from month to month, but keeping tabs on national average rates can help you distinguish a good deal from a bad one. According to Bloomberg, interest rates have been falling since 2014, reaching a low of about 3.4% in September 2016 before spiking up to 4.32% by the end of the year. Changes in the national average can give you a ballpark figure of what to expect, but don’t forget that your lender and credit ratings will also play a part in determining your interest rate. Before you finalize a loan, be sure to shop around, and always ask for estimated interest rate changes.
What Your Monthly Payments Will Look Like
Just because your monthly mortgage payment is less than your current rent, that doesn’t mean you’ll have rolls of cash at your disposal. As a homeowner, your expenses go beyond a monthly check. In addition to the mortgage payment, you should plan on saving 1% to 4% of the home’s value for home maintenance costs — which will crop up sooner than you think. Remember, too, that you have monthly insurance payments, as well as annual property taxes — those can be significant, so you should start saving for them well in advance of April 15. If you have an escrow account, though, insurance and taxes are automatically added to each mortgage payment to ensure those bills are paid.
The Necessity of Mortgage Insurance
Mortgage insurance allows lenders to protect themselves in the event that their loan recipients aren’t able to make their mortgage payments. Generally, if you put down more than 20% of the home’s purchase price, you won’t be required to have PMI (private mortgage insurance). Although a smaller down payment would allow you to purchase a home you couldn’t otherwise afford, the PMI payments will increase your monthly payment, adding to the total amount paid for the home.
A Loan Isn’t Always Forever
One of the most intimidating things about homeownership is how irreversible it feels. Mortgage, after all, is a word derived from Medieval French law, loosely translated as “death pledge.” When you sign for a 30-year mortgage, it’s easy to feel like the next three decades are set in stone. But that’s not necessarily true.
You do have to invest some time in the home — selling for a profit in less than two years can subject you to a capital gains tax, and just think of the transaction fees piling up — but a home loan doesn’t doom you to the same address for the rest of your pre-AARP days. You can always move, although to buy a new house while you have an existing mortgage, you would have to contact your lender for the payoff amount, and then decide if you want to move first or sell first. (Your real estate agent is a great resource for navigating this situation.) Also keep in mind that you can qualify to refinance your loan later down the road if interest rates drastically drop, or if you’d like turn your adjustable-rate mortgage into a fixed-rate.