Homeownership can be expensive. That’s why families and individuals take out mortgages. However, mortgages can be intimidating and confusing. Whether you’re looking for a mortgage refresher or doing research for the first time, we have you covered. 

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In this comprehensive guide, we’ll discuss the basics like “what is a mortgage?”, “how do mortgage payments work?” and other questions would-be homeowners might have. 

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Click Here To Connect With Wesley Mortgage And Begin Your Mortgage Journey Today

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Mortgages 101

A mortgage is a loan that can be used to either buy or refinance a home. Lenders expect each buyer to pay off the entirety of the loan in predetermined amounts over a fixed amount of time. Mortgages are secured loans, which means that borrowers pledge their homes as collateral to be a financial safety net for the lending agency. 

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Thus, there’s always a risk of repossession or foreclosure if a borrower fails to make payments on time. Albeit, many lenders assess an individual borrower’s capacity to fulfill their dues before granting a mortgage. 

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Mortgage Jargon Explained

On top of the fees and paperwork, applying for mortgage loans means encountering an array of technical terms and jargon. Even a basic understanding can make a world of difference when deciding on a suitable loan, so we’ve outlined the most common ones: 

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• Lender: the organization or financial institution that grants loans.
• Borrower: the person applying for a loan or mortgage.
• Amortization Table: lists the payments and how much goes to interest versus the principal.
• Down payment: the initial payment when applying for a mortgage. More often than not, it is equivalent to 20% of the home’s value.
• Escrow account: an account from a third party where the lender deposits part of the insurance expenses and other fees. 
• Annual Percentage Rate (APR): the sum of the interest payments plus additional fees. If you have no other fees, the APR equals the interest rate. 

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How Do Mortgage Payments Work?

Taking a mortgage means that you’ve agreed to a lender’s terms and make payments on time. But how do mortgage payments work? 

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The payment is determined by the size and term length. Loan size refers to how much money is borrowed while mortgaging the house, and term length is how long one has to pay it back. 

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As for the billing term and schedule, payments begin one month after closing. Expect to receive subsequent invoices on the first of every month, with charges corresponding to the prior month. 

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Mortgage Payment Components (PITI)

The creditor will provide an amortization table, which is a breakdown of fees. In it, each payment has four components: principal, interest, taxes, and insurance – otherwise known as PITI. 

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Understanding what they mean will help you stay on top of each payment. 

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Principal

The principal is the total money borrowed from the creditor. A portion of the payment is reserved for paying back the balance on the loan’s principal. Many loans are structured so the initial billing statements include a smaller amount of the principal, which increases as time goes on. 

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Interest

The mortgage interest rate is what needs to be paid on top of the principal. Interest is compensation for the financier. There are two interest rates, fixed and adjustable, which will be expounded on later. 

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Interest rates impact how large the payments are, however, they can vary. 

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Taxes

Real estate or property taxes are evaluated by government agencies and allocated to fund public services such as schools, infrastructure, and local fire departments.

Property taxes are calculated yearly, but it is also possible to include them as part of the payment. These are calculated by dividing the total tax by the number of payments in a year. Until taxes have to be paid, the lender will hold them in escrow. 

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Property Insurance And PMI

Similar to payments made toward property taxes, the home insurance payment is held in escrow until the bill is due. Given this, two kinds of mortgage insurance may be applicable: 

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The first is property insurance, which protects the home in case of fire, theft, or natural disasters. The other is private mortgage insurance or PMI, which is required if you provide less than a 20% down payment. PMIs protect the lender against the possibility the borrower defaults.

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Mortgage Term

The length of the mortgage, or the mortgage term, has a significant impact on how much money you have to put down for the monthly payment. Standard mortgage terms can be 10, 15, or 30 years, but many lending institutions have options to complete payments within a shorter period. However, shorter mortgage terms involve a higher payment for better rates.

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What Happens If I Don’t Pay The Mortgage? 

As we mentioned earlier, there is a risk of foreclosure when payments are not made on time. Albeit, lenders give borrowers up to 15 days to settle. If the borrower still hasn’t settled the balance after this grace period, creditors might reach out with reminders and a bill for late fees. 

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If the payments remain unfulfilled at this stage, the lender may file a “notice of default”. At this point, the house will be put on the market to either be sold to another buyer or auctioned off to settle the loan’s balance. 

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How To Qualify For A Mortgage

Mortgage availability depends on the lender’s total capacity or how in-demand loans are, but this isn’t the only thing to consider. Most of a mortgage’s qualifying factors are well within the borrower’s control. To keep things simple, qualifying for a mortgage comes down to credit score, debt-to-income ratio, income, and the down payment. 

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Credit Score

The credit score is the most important factor when applying for a home mortgage loan. Many lenders require a minimum FICO score of 620 for fixed-rate mortgages and 640 for an adjustable-rate mortgages. Government loans are more lenient and may accept credit scores as low as 500.

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Income

Creditors also assess buyers by their gross monthly income (which means their income before taxes). Compliance with income evaluations is limited to pay stubs and tax forms, which means that income like signing bonuses aren’t counted. Other income sources, like dividends from investments or rental income, may only be considered if pay-outs are regular. 

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Debt-To-Income Ratio (DTI)

The debt-to-income ratio is calculated by dividing the monthly loan payments by the gross monthly income. Computing the DTI helps lenders assess a borrower’s capacity to manage loan payments versus what they earn. Most creditors require a DTI of 45%, or that the payments account for no more than 45% of the monthly income. 

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Borrowers with a high credit score and at least two months’ worth of payments in reserves may qualify with a DTI of 50%. Reserves refer to funds in bank accounts, investments, or retirement plans. 

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Down Payment

Based on the lender and their corresponding guidelines, you may qualify for down payments as low as 3% of your home's total value. Borrowers with higher credit also qualify for lower down payments. Still, most down payments equivalent to less than 20% of the loan will require private mortgage insurance (PMI). 

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Types of Mortgages

The next step is exploring the mortgage options on the market. Depending on your financial situation and credit rating, you may qualify. We recommend considering several lending agencies or institutions to get an idea of what you need. 

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Fixed-Rate Mortgage

With a fixed-rate mortgage, the interest rate does not change over the entire tenure of the loan. Unlike other loans, the principal and interest payments do not fluctuate based on the housing market’s movements. A fixed-rate mortgage loan is also called a traditional mortgage. 

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Adjustable-Rate Mortgage (ARM)

Adjustable-rate mortgages start with specific interest rates but fluctuate. This loan’s initial interest rate may be lower than its fixed-rate alternative, but there is always a possibility of the payments increasing. Many borrowers opt-in for an adjustable-rate loan when housing market rates might plummet. 

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Balloon Mortgage

Balloon mortgages are a riskier option. Payments start low and “balloon” toward the loan's end. This type of loan appeals to borrowers who may experience an increase in their income or plan to sell the property before loan completion. 

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FHA Mortgage

The Federal Housing Administration backs an FHA mortgage. While the FHA doesn’t grant loans, they reimburse creditors if a borrower defaults. This elevates a lender’s tolerance for risk, which improves the likelihood of getting a loan. This means borrowers with lower credit scores have a chance of securing this mortgage. 

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USDA Loans

The Department of Agriculture-backed USDA mortgage loan is reserved for homebuyers in rural or suburban areas. This loan is given to families that have a demonstrable need for financial aid. Therefore, interested parties may not have a household income that exceeds 115% of the area median income. Many qualified borrowers take this loan because of its 0% down and low-interest rate. 

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VA Mortgage

A VA mortgage is backed by the Department of Veterans Affairs and is an excellent benefit for qualified veterans and other service members. These mortgages are one of the most lenient borrowing requirements while also having a 0% down and low-interest rate, making them ideal for veterans and their spouses. 

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Similar to other government-backed loans, The Department of Veterans Affairs doesn’t provide VA mortgages. Instead, this mortgage is issued by recognized third-party institutions that are reimbursed by the VA in case of default. 

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Advantages And Disadvantages Of Getting A Mortgage

It’s essential to consider the pros and cons of having a mortgage. Note that while every mortgage is different, they have shared advantages and disadvantages that the discerning borrower should ponder: 

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Advantages

• Improved credit score: Making consistent payments on the loan increases a credit rating over time, impacting the loans you can apply for. A stellar credit rating qualifies you for a lower interest rate. 
• Affordable homeownership: Many people can’t pay for their entire home in cash. A loan split over manageable payments with an acceptable interest rate makes owning a home more attainable. 
• Tax benefits: Some mortgage insurance premiums may result in a tax deduction. For people that might be selling their homes, part of the sale may also be tax-deductible.

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Disadvantages 

• Risk: Because mortgages are loans secured by your home, there is always a risk of losing it if you can’t keep up with the payments. If a borrower loses their home during foreclosure, the money paid until that point cannot be retrieved. 
• Property value depreciation: As with any property, the home may lose value. If the housing market drops, you may have a mortgage balance more significant than the actual home value. 

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The Bottom Line

Taking out a mortgage is a great way to make owning a home more feasible, but careful planning and research make a significant difference. Mortgages are not a one-size-fits-all product. It’s crucial to identify what your needs are as well as what you can handle in terms of payments. 

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Your credit score, income, and DTI determine what mortgage you can qualify for. Potential homebuyers with lower credit ratings can also apply for government-backed loans, while people with higher credit ratings may get better interest rates.

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Whatever your goals are, we can help. Contact Wesley Mortgage to get the perfect loan for your dream house.

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Click Here To Connect With Wesley Mortgage And Begin Your Mortgage Journey Today

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