What is a Mortgage?
A mortgage is a legal document giving a lender a lien on real estate to secure repayment of a loan. A mortgage loan is used to buy or refinance a house. The house is collateral for the mortgage loan.
To pay off a mortgage, you make monthly mortgage payments. Your monthly payment is usually divided into four parts: Principal, Interest, Taxes and Insurance (PITI). For the first half of your loan term, most of your payment is applied to interest. Some loans also include payments for private mortgage insurance.
Types of Loans
There are many different types of mortgage loans. Most borrowers choose a 30-year term, but loans are also available in 15-, 20- and 25-year terms.
Fixed-Rate Mortgage
A fixed-rate mortgage is stable because the interest rate is set for the term of the loan and you make the same monthly payment of principal and interest for the life of the loan. This stability makes it easy to plan a budget and manage your finances.
Adjustable-Rate Mortgage (ARM)
An ARM usually starts with a lower interest rate than a fixed-rate loan. After the initial period, which ranges from 6 months to 7 years, the rate will adjust up or down annually (or semiannually) for the life of the loan based on a specified index. Your monthly payment changes as the index changes. The ARM features a lifetime cap, which is determined at the time you lock in your interest rate. You know from the start the maximum rate on your loan.
Combination Mortgage
You receive a first mortgage combined with a second, smaller mortgage (home equity loan) at the same time for a total combined mortgage of up to 90% of the house price. With this option, you avoid the cost of private mortgage insurance while still being able to make a small down payment. And you can get a larger mortgage without paying the higher interest rate of a jumbo loan. The most popular combinations are 80-10-10 (80% first, 10% second, 10% down payment) and 80-15-5 (80% first, 15% second, 5% down payment).
Choose a Loan
Finding the loan that’s right for you depends on several factors, such as how long you plan to stay in your home and your financial goals. Consider how quickly you want to repay the loan. The sooner you repay your loan, the more you’ll save in interest and the faster you’ll build equity. However, the longer you extend your loan, the lower your monthly payments will be.
Use the loan amount and monthly payment calculators to help you determine how quickly you want to repay the loan. Enter the loan term and interest rate for the mortgage(s) you are interested in to see what your monthly payment would be. To consider different loan terms, change the number of years in the Term field.
Pre-Qualified vs Pre-Approved
Pre-qualification is an informal estimate of how much of a home you can afford. It is based solely on what you verbally tell the lender about your income and debt obligations. The lender does not verify any information and does not provide a written letter stating the amount of money you’re qualified to borrow.
There are no fees involved with pre-qualification.
It’s a good idea to go a step further and get pre-approved. When you get pre-approved, you are actually beginning the loan application process. This means the lender will verify your credit rating, employment history, income and assets. Once your offer on a home is accepted, final approval of your loan can be completed more quickly, since your financing has already been arranged. Please note the lender will put your pre-approval in writing. Some lenders may charge pre-approval fees.
Rates and Points
As you shop for mortgages, you may see two similar types of rates: mortgage interest rate and annual percentage rate (APR). It is important to understand the difference between them.
The interest rate is the cost for the use of a loan. It is usually expressed as a percentage of the loan, paid over a specific period of time. The interest rate does not include fees charged for the loan. Unlike your interest rate, the APR includes other charges, such as the origination fee, to reflect the total cost of the loan over the life of the loan.
Your monthly mortgage payment (principal and interest) is calculated on the mortgage interest rate - not the APR.
Points (also known as discount points) are paid by the borrower to the lender to obtain a lower interest rate. Each point is equivalent to 1% of the loan amount. For example, on a $100,000 loan, one point would equal $1,000. Typically, a borrower can purchase from one-quarter of a point to three points.
The origination fee is charged by the lender to cover the cost of issuing the loan and is typically 1% of the loan amount. This fee is charged whether or not you purchase points.
Private Mortgage Insurance
If your down payment is less than 20% of the home purchase price, you can expect to pay private mortgage insurance (also known as PMI). With private mortgage insurance, you can buy a home with a lower down payment than the lender usually requires. Two federal agencies, the Federal Housing Authority and the Veterans Administration, provide insurance for some of their mortgage loans.
The cost of private mortgage insurance varies, depending on your down payment and the type of loan you select. It is usually included in your monthly payment, along with principal, interest, and taxes. Private mortgage insurance ensures that the lender is protected in case you default on the loan.
Choose a Lender
All lenders want your business. Most lenders are trustworthy and will work with you to make sure you get the right loan - with the right terms and monthly payments that fit your budget.
Unfortunately, some lenders engage in what’s called “predatory lending” practices. They lure in buyers with bad credit or no credit history and convince the buyers that they can’t get a mortgage elsewhere. Some homebuyers who borrow from this type of lender may be at high risk of not being able to repay the loan, which could ruin their credit and cause them to lose their home.
Predatory lending practices include:
- Offering a mortgage loan with a very high interest rate.
- Adding points to a loan without lowering the interest rate.
- Including unnecessary costs, such as the purchase of credit life insurance.
- Adding questionable fees and unnecessary charges, such as requiring the purchase of credit insurance. This practice is called “packing.”
- Encouraging the borrower to frequently refinance a loan, charging high fees each time. This practice is called “flipping.”
- Bases the loan on the value of the property instead of the borrower’s ability to repay the loan. When the borrower defaults on the loan, the lender not only acquires the property, but also the borrower’s equity, leaving the borrower with nothing. This practice is called “equity stripping.”
Make Your Wish List
Think about the size house you will need. Use the New Home Wish List to help you organize what you want, and share it with your real estate agent.
You should also think about the condition of the home -- if you want a fixer-upper, a brand new home or something in between. Of course, there are degrees of fixing up, so be clear with your real estate agent about how much work you’re willing to do.
As you look at homes, use the Potential Home Checklist to record the condition of the property. This will be especially helpful when you order a professional inspection on the home you’ve agreed to purchase.
Work with a Real Estate Agent
Finding the perfect home takes time. A real estate agent can make your search faster and easier. To find a good agent, ask your mortgage professional, friends, family members, your lawyer and/or financial advisor.
A good real estate agent:
- Helps you find a home that meets your needs
- Tells you about the neighborhood and schools
- Presents your offer to the seller
- Offers advice during the negotiation process
- Can help coordinate the home inspection and closing
The real estate agent gets paid a commission when the house is sold. Usually, the seller pays this commission, and factors it into the selling price.
The Right Neighborhood
You're not just moving into a home, you’re also moving into a neighborhood. When you see a house you like, drive around the area to see what types of amenities are nearby, such as grocery stores, other retail stores, dry cleaners, gas stations, public transportation, local library, etc. See how far the location is from where you work. If possible, visit at different times of the day to see how light affects the house, as well as traffic patterns which indicate how busy the neighborhood gets. Contact the local government about zoning restrictions, which could affect major renovation projects and additions you envision.
In addition to your own observations, ask your real estate agent to give you a copy of the area’s comparative market analysis (CMA) to make sure the seller is asking a fair price. Have your agent show you other listings in your price range for comparison as well.
STEP 2: BUYING
An exciting, yet sometimes challenging process.
Now that you know what you want and know what you can afford, you're ready to shop with confidence. Looking at houses is the fun part; dealing with the paperwork less so. This section will help de-mystify the mortgage application and closing processes.
This is also the time when reality meets up with your dreams. You may discover your budget can’t accommodate what you ideally want, or you’re competing with other buyers in a very hot market. Be patient. With the help of a good real estate agent, you will eventually find the right house and with a good lender, the right mortgage that you can comfortably afford.
Make An Offer
Negotiation
You’ve found a home. When do you make an offer?
Depending on your personal situation and the housing market climate, you may want to make an offer right away, or you may choose to wait. Confirm how much cash you will need in order to purchase the home, such as down payment and closing costs. Your lender can help you determine the amount.
Earnest money
In many parts of the country, you will need to put down earnest money to show your commitment is serious. Your real estate agent can advise you on how much earnest money to put down. This money will be applied toward your down payment or closing costs should the offer be accepted.
Purchase Agreement
Once the seller has accepted your offer, your real estate agent will help you prepare a purchase agreement, also known as a sales agreement or "offer to purchase." It describes the following:
- Description of the property and its location
- Items that come with the home (appliances, lighting fixtures, etc.)
- Items the seller will remove
- Purchase price
- Down payment
- Earnest money, if applicable
- Financing details
- Buyer and seller attorney information
- Desired closing date
- Date the purchase agreement expires
- Contingencies (see page 2)
Apply for a mortgage
Submit Your Application
Regardless of whether you decide to get pre-approved or not, you will have to provide several types of financial documentation to the lender. This information is necessary to verify that you have the funds to pay for the down payment and closing costs and the income to afford the monthly payments.
Most lenders charge an application fee. Some lenders charge additional fees for ordering a credit report and appraisal.
The number of copies and specific documents a lender requires may vary, but basically, you can expect to provide the following:
- Employment information
- W-2s
- Current pay stubs
- Tax returns
- Current debts
- Bank statements and other financial documents
See the Financial Information Checklist for a description of documents the lender may require.
The lender will also pull a copy of your credit report to verify your credit history.
Based on your financial information and credit history, the lender will put in writing the maximum loan amount for which you are pre-approved.
Then, once you have signed a purchase agreement, to complete your application, you will need to:
- Submit any application fee(s) required by the lender
- Forward a copy of the purchase agreement to the lender so they can get an appraisal on the property
- Finalize your loan type and rate with the lender
- Decide if you want to purchase points
- Provide any additional financial documentation required by the lender (e.g., a gift letter from a relative who is contributing down payment funds that will not need to be repaid)
- Sign and return any disclosures (they vary by region - ask your lender or real estate attorney to explain them to you)
Lender Disclosures
Within three business days of receiving your application, the lender is required by law to send you the following federal disclosures and disclosures specific to the state where your property is located:
-Good Faith Estimate, an itemized list of estimated closing costs. Since you will have to pay these costs, this estimate alerts you to the additional cash you will need at closing. Costs may include:
- Home appraisal
- Survey
- Pest inspection report
- Origination fee
- First-year private mortgage insurance premium, if applicable
- First-year home owner's insurance premium
- First-year flood or earthquake insurance premium, if applicable
- Title insurance
- Recording and transfer charges
- Attorney’s fees
- Escrow account fee
-Truth In Lending statement (TIL) which fully discloses the rates and terms of the loan the lender is offering:
- Annual Percentage Rate (APR)
- Amount financed
- Finance charges
- Total number and amount of monthly payments
- Total amount of payments
- A Home Buyer’s Guide to Settlement Costs, a government publication explaining the types of expenses that need to be paid at closing
Lock In Your Rate
Once you’ve reached an agreement with your lender on the type of mortgage loan, you will want to consider “locking in” your interest rate. This will protect you from any rate increase if interest rates rise while your loan application is being processed. Discuss this possibility with your lender as well as any fees the lender may charge to lock in the rate.
You have two opportunities to lock in your interest rate: At the time you submit your loan application or afterwards - up to 5 days prior to closing.
Please note once you lock in your rate, if interest rates fall, you will not be able to receive the lower rate. If you decide to lock in your rate, make sure your lender puts in writing when the lock-in takes effect and how long it will last - it should last through the closing date listed on your purchase agreement.
Property Valuation
By requesting a mortgage loan, you're putting the home itself up as collateral. Naturally, the lender will want to know that the home is worth at least as much as the loan amount, which is why property valuation, or appraisal, is required.
The lender hires a real estate appraiser and passes the expense on to you as part of the closing costs. The appraisal provides an estimate of the home’s market value. It is based on what at least three similar houses in the neighborhood recently sold for, coupled with the specific conditions of the house you are purchasing.
Some lenders use an alternative to an appraisal, called a home evaluation. Instead of sending a person to look at the property, they use a database that pools information on recent sales and tax assessments to determine the value of your property. While this automated process may be less expensive, it does not assess the interior condition of the home. Only an appraiser can do that.
Loan Review
Loan review, or underwriting is when your mortgage application is evaluated. The lender’s underwriter typically considers these criteria when reviewing your loan.
Monthly Cash, Debts, Credit History, Assets, Appraisal
The review process generally takes a few weeks. The sooner you get all the necessary documentation to the lender, the sooner they can review it.
Warning!!! DO NOT make any large purchases or have any other company run your credit during this process. Your credit rating will drop!
Closing
Inspection
Your offer has been accepted. Financing has been arranged. The last bridge to cross is closing, also known as “settlement.” While closing practices vary around the country, closing is when all the final papers are signed, money changes hands and the title to the property is transferred to you.
Why Pay for an Inspection?
The most important closing activity that you are responsible for is the home inspection. While not required by the lender for loan approval, it is strongly encouraged because it can only benefit you, the buyer. It is important that you attend the home inspection to ensure it is being done properly to protect yourself from unexpected, costly problems that could arise after you move in.
What Does a Professional Inspection Cover?
A home inspection is an objective examination of the home’s exterior and interior physical structure and systems. Hire an inspector who is a structural expert and knows how to evaluate hidden structural defects and high-cost maintenance items, such as electrical, plumbing, heating, air conditioning, hot water heater and appliances. The inspector will also look for termites, mold, water damage, roof leaks and foundation cracks and more.
If the inspector finds problems, it doesn’t necessarily mean you shouldn’t buy the house. The seller may lower the price or pay for the repairs. But if you decide not to buy the house, based on the inspection, you could lose your upfront costs, such as fees for the credit report and mortgage application.
Prepare for Closing
The purpose of closing is to make sure the property is ready to be transferred to you from the seller. Who conducts the closing varies by state. The closing agent could be your lender, a title insurance or escrow company, your real estate broker or a real estate attorney who represents you or the seller.
In any case, here are the activities both you and your lender must perform in order to ensure a successful closing:
What you do?
Inspection
Hire an inspector who is a structural expert and knows how to evaluate hidden structural defects and high-cost maintenance items, such as electrical, plumbing, heating, air conditioning, hot water heater and appliances. The inspector will look for termites, mold, water damage, roof leaks and foundation cracks.
Homeowner’s insurance binder
Get proof from the insurance company that you have insurance for the property that covers hazards, such as fire, theft or damage to your property. Your lender will tell you the types and amount of insurance you must obtain prior to closing.
Well, sewer or septic and termite certificates
Contact local or county government to certify that the water supply and sewage work properly and that the property is free of termites or other wood-destroying insects. The sales agreement will state whether you or the seller is responsible for paying for these certificates.
Down payment
Any earnest money you deposited will count toward the down payment.
What your lender does?
Appraisal
Hire an appraiser to assess the property’s value and how it compares to surrounding homes.
Title search and report
Research of land records, court records and other legal documents to determine if the seller has a clear title to transfer.
Title insurance
This protects the lender against title risks that did not appear in the public record during the title search. These risks include recording errors, forgeries and claims from unknown heirs, any of which can challenge the legality of your ownership. You will need to purchase title insurance for your lender. You can also purchase title insurance for yourself to protect your interests.
Title insurance binder
A result of the title search, this assures the lender that the title to the property qualifies for title insurance.
Survey
Confirm the property’s boundaries as described in the sales agreement. A survey is not required in all states.
Closing Day
Your purchase agreement usually allows for one last walk-through of the property within 24 hours of closing. Most people walk through on closing day. This is your chance to make sure the seller has completely vacated the property, that all mechanical and electrical systems are in good order and that any agreed-upon repairs have been made. You can delay the closing if you feel the terms of the purchase agreement were not met.
The closing is usually held at the closing agent’s office. People in attendance may include: you, your real estate agent, your attorney, your lender, the seller, the seller’s real estate agent and the seller’s attorney.
When you arrive at your closing, the closing agent will review with you all documents that you need to sign and go over the funds needed for closing, which should be paid in the form of a cashier’s check. If you live in an area where there is no formal closing meeting, the escrow agent will handle all the arrangements, ensuring documents are signed and the funds are disbursed.
Now that you’ve just turned over the biggest check of your life, breathe a big sigh of relief. Congratulations, you’re a homeowner!
Manage Your Loan
Staying on top of your mortgage and making prompt monthly mortgage payments is extremely important. Mortgage brokers offer several services to help make prompt payments easier.
STEP 3: OWNING
Welcome to the world of home ownership.
Now that you’re a homeowner, you’re ready to experience the joy of turning your house into the home of your dreams - decorating and fixing it up to suit your needs. It’s the best part of being a homeowner. Taking proper care of it will ensure it continues to increase in value.
This section will address some of the ongoing maintenance issues and additional financial responsibilities that come with home ownership, as well as how to tap into your home’s equity to pay for improvements and other major life expenses. Your home is your greatest financial asset. Take proper care of it and most likely, it will do the same for you.
Moving
You should plan your move as far in advance as possible - as early as eight weeks if possible. If you are not moving long distance, it may be less costly to rent a truck and ask family and friends to help you. However, there is significant effort in moving. You will be surprised by how much even a small studio apartment can hold. Many find in hindsight that hiring professional movers was well worth the money.
Estimate the cost of a move
To decide whether it’s better to move yourself or hire professional movers, get several estimates from movers. Compare against the costs of renting a truck and the time and physical effort it will take to do the move yourself. Movers will ask you how many items you have - how much is fragile, how many beds, paintings, TVs, etc. as well as how many items they’ll need to pack.
Take an accurate inventory of your items. Ultimately the moving company is estimating the weight of your move, as pricing is frequently estimated on a per-pound basis. Your answers will also be used to estimate the number of people needed for the job as well as the time required. Differences in labor rates will also impact the quote.
Transition Costs
Everything’s packed. The mail has been forwarded. The new keys are on your chain. And suddenly you have a list a mile long of things to buy and do for your new home. It’s all part of getting settled, and it’s smart to budget ahead for these expenses.
Here are some projects you may want to tackle in the short-term. Prioritize and focus on the ones that best address your needs for comfort and security. Some projects, like painting, are easier to do before you move in when there’s no furniture around, but of course, they can be done after you move in.
Painting and refinishing floors
You may want to consider taking on the project yourself to save money, but don’t underestimate the effort because there may be quite a bit of preparation. You may need to patch up holes, sand down uneven areas, etc. Painting costs will vary depending on how much you’re painting, the number of coats, and the quality/brand of the paint. All in all, a paint job can easily run several thousand dollars.
Refinishing hardwood floors can also make your home feel new. Depending on whether you do it yourself or hire a professional, its cost can also range from several hundred to several thousand dollars depending on room size and quality of materials.
Security Alarm System
There are many ways to help make your home more secure from potential intruders - from using $100-200 dead bolt locks to installing sophisticated alarm systems. Costs for alarm systems can easily range from several hundred dollars to several thousand dollars depending on the type of system you choose. Both wired or wireless systems typically have monthly fees starting at $29 per month for basic service and offer options that may increase your monthly fee another $20-40 per month. Some security alarm companies can even provide smoke monitoring or interrupt electrical service in the event of an emergency. The peace of mind that comes from knowing your house is safe and secure when you’re away or asleep may well justify its cost. Since 1992, the number of homes with a professionally installed alarm system has almost doubled.
Home Maintenance
Taking regular care of your appliances and checking plumbing and heating/cooling systems regularly can save on costly repairs or even more costly replacements. Review your home inspector’s report to help you prioritize tasks. It is worthwhile to consult a professional for anything you have a hard time fixing or inspecting. Some professionals may charge a fee.
Foundation
Your home’s foundation requires periodic maintenance to ensure the moisture of the soil around your home remains relatively constant. Soil that is too dry or too wet may lead to structural problems requiring costly repairs. If you need work done on your foundation, contact a local licensed civil engineer who can inspect the condition of the foundation and hire a licensed contractor to do the work.
Drainage
Improper drainage can lead to damage of your home’s foundation. To maintain a constant level of soil moisture around your home, consider these common best practices:
- Keep at least two to four inches of concrete showing below the brick or siding.
- Keep the gutters clear - every spring, remove leaves and other debris that have accumulated during winter storms.
- Check that drainage channels move away from your home. Make sure pockets of standing water do not develop around your home.
Energy Savings
Many homeowners find that they have higher utility bills, especially if they’ve moved into a larger space than what they were renting. Also, some renters don’t have to pay for water, but as a homeowner, you do.
Taking care to conserve energy in your home will save you money on utilities. Here are some popular ways that are easy to incorporate into your routine:
- Turn off the lights in unoccupied rooms.
- Control the thermostat setting to a comfortable temperature when you are at home and adjust the setting when you leave the house to reduce your energy costs. It might also be beneficial to purchase a programmable thermostat.
- Run the dishwasher, washing machine and dryer only when they are fully loaded.
- Water lawns and gardens in the morning before to avoid evaporation and ensure the water soaks down to the roots.
- Turn off the water when you are shaving or brushing your teeth.
See the Ways to Make Your Home More Energy Efficient checklist for more easy tips.
Home Improvements
You have visions of color and comfort. The back porch could use a fresh coat of paint. The kitchen cabinets need to be updated. The bathroom hasn’t changed since the ‘70s.
How far do you take your home improvements? When do cosmetic changes (paint, window treatments) turn into major remodeling and renovation (custom cabinetry/countertops, new tile/tub/fixtures, additions) projects?
To keep the cost of remodeling from increasing dramatically (as many projects frequently do), it’s best to set a budget first and work to maximize the features you want within that budget. This may also help set the limit between cosmetic and major improvements.
Many homeowners believe that any improvement will automatically increase the value of their property. Appraisers offer a more cautious perspective. In general, projects that add square footage to bring your house up to - but not way beyond - neighboring house sizes provide the greatest return. In other words, if you live on a street of modest 2-3 bedroom bungalows, don’t turn your home into a 6-bedroom mansion.
Likewise, don’t add an in-ground swimming pool if your home will be the only one in the neighborhood to have one. Not all buyers want the added expense of pool maintenance. Cosmetic changes such as new paint, flooring and window treatments are considered matters of personal style and therefore, add the least amount of value to a home.
Understand Home Equity
You didn’t just acquire a mortgage. You also acquired a great asset: equity in your home.
The equity you have in your home is defined as the difference between the market value of your home and what you owe on it. Because home values fluctuate depending on the housing market and local tax assessments, your home equity can change frequently over time. As home values rise, your equity increases. As home values fall, your equity decreases. And, as you pay down your mortgage, your equity increases.
The benefit of home equity is that you can tap into it at any time during its availability period for almost anything. Home Equity Borrowing can cover other major expenses beyond home improvements, such as college tuition, the purchase of a new or pre-owned car or to consolidate debt from other loans.