Mortgage 101: Your Basic Questions Answered
First-time home buyers often have more questions than answers, and it can be frustrating. Even those who attempt to research and study the process get bogged down in acronyms and large, scary looking numbers. If you’ve never bought a home, understanding the answers to the most basic of mortgage questions builds confidence to ask more detailed questions later during the process.
The quest for knowledge instills the importance of finding professionals such as real estate agents and mortgage bankers who know their trade and can translate lending details into information an everyday person can comprehend.
Studying mortgage information and understanding a simple version of the process is the best way to begin deciding if homeownership is in your future.
What is a mortgage?
In very simple terms, a mortgage is a loan that a bank or mortgage lending institution provides buyers to acquire a house. In return, the house becomes collateral if the financing cannot be paid by the borrowers.
Typically, mortgages are paid monthly and, although paid in one sum, there are four components within: principal, interest, taxes, and insurance.
- Principal: the total amount of money borrowed to purchase the home.
- Interest: the percentage of money paid to the lender for the opportunity to borrow.
- Taxes: refer to property taxes paid by the owner, normally tallied by the value of the house.
- Insurance: homeowners insurance is required by lenders.
How do I find a mortgage banker?
Reputations speak volumes in this industry. Finding a trusted friend or family member who had a great experience with someone knowledgeable and with a willing spirit is the best option, especially for first time buyers. Real estate professionals also like to refer their favorites because they want the transaction to be done competently and in a timely fashion, which makes for a smooth process for everyone.
What is the difference between prequalification and preapproval for a mortgage?
Pre-qualification is the first step for securing a mortgage; a lender has done an initial screening of your finances. Pre-approval is a more in-depth scrutiny from the lender which requires financial documents to be verified. A pre-approval letter from a bank demonstrates to sellers and real estate agents your financial capacity to borrow.
What is the difference between a credit and a FICO score, and what are they used for?
A credit report is a list of any credit activity, such as borrowing and repaying, and determines the way the credit score is calculated. Credit scores are higher if payments and debts are in check and up to date. Late payments and too much debt for your income are scored negatively. Credit history and types of credit (car, student loans, etc.) are also computed for your credit score. Excellent credit is considered at a score of 720 and above, while Fair credit is scored between 620-659.
Your FICO score, originally known as the Fair, Isaac, and Company score, is also considered when applying for a mortgage. The FICO score is computed by the information found on your credit report. There are three credit reporting agencies and each has their own FICO score assigned to you. Maintaining accurate credit reports with Experian, TransUnion, and Equifax helps to ensure accurate scores across the board.
FICO scores range from 300-850 and a score near 600 becomes problematic for obtaining credit and loans. Mortgage lenders use FICO scores to determine interest rates and eligibility for different loan products.
What are the fees I pay with a mortgage?
The flat out repayment of the loan isn’t the only money associated with paying the mortgage each month, although it feels like it because buyers routinely roll fees into their monthly mortgage payment. During closing, buyers are usually responsible for costs, but there are times when sellers work with the buyers and offer credit to help the deal go through.
Common fees include:
- Tax service provider
- Title insurance
- Other government taxes, property taxes, and homeowners insurance.
What is an escrow account?
The escrow is the money or paperwork needed for closing of the home, but is held by a nonaligned third party. The homeowner can also pay into an escrow account held by the lender to cover taxes and insurance.
What is a closing?
This closing is the last part of a real estate deal. The closing date is typically agreed upon during the negotiation portion of the transaction, and is normally several weeks after a formal offer is accepted. On the closing date, the buyer finally becomes an owner.
What is the difference between an interest rate and an APR?
The interest rate and APR affect the total amount of repayment of the mortgage. Veterans United Home Loans explains the difference as such:
"The Annual Percentage Rate (APR) is the annual cost of a loan expressed as a percentage. When you receive a Truth In Lending (TIL) statement from your mortgage company the APR will be disclosed. Lenders are required by law to provide you with the APR within certain time frames under the Truth In Lending Act (TILA). The APR takes into consideration the following items:
- Interest rate
- Origination fees and costs
- Closing agent fees
- Discount points
- Other fees dependent on the specific transaction
The APR that you are quoted will likely be different from the interest rate because these other fees are also considered. By covering the overall cost of the loan, it becomes easier for the borrower to compare different loan products and mortgage companies. When shopping for a home loan, it is best to compare the APR rather than the interest rate to find which company is offering the most competitive overall deal."
Is a VA Loan the best for a military family?
Often it is, but each applicant’s story is different. This is where the need for a knowledgeable mortgage banker is crucial. The VA Loan product is a very good opportunity for veterans and active duty members because of several key points. The loan does not require a down payment or mortgage insurance, and interest rates remain competitive.
Do I need homeowners insurance?
If borrowing from a lender, yes, homeowners insurance is required. In reality, owning a home without insurance is extremely dangerous and shouldn’t be considered optional in any case. Homeowners insurance not only protects the owners from physical property damage from a wide range of destructive factors, but from legal and financial disasters as well.
Securing a mortgage and officially buying a home is a long, detailed journey. Understanding a few key basic concepts before wading into specifics gives potential buyers power to continue to be informed and investigate the best options for their financial and lifestyle obligations.
By Dawn M. Smith
Photo attribution Creative Commons 3 - CC BY-SA 3.0 by Nick Youngson