What is a mortgage?
A mortgage is a type of loan used to purchase a home or other type of real estate, as an alternative for paying the entire purchase price up front.
When you apply for a mortgage through a lender, they’ll ensure you meet specific requirements, such as having a certain credit score and being able to pay at least part of the home’s value.
The portion of the home’s price you pay up front is called the down payment. Increasing the size of your down payment decreases what you’ll owe on a monthly basis as you pay back the loan.
Generally, the balance of what you owe on the house is divided over a series of regular payments over a fixed period of time. Money you put toward paying back your mortgage is divided into interest payments and payments toward the loan’s principal.
While your payment is likely to be the same every month, early payments you make will be much more heavily weighted toward interest, while later payments will chisel down the principal.
Once you repay the loan — principal and interest — over a set number of years, you own the house free and clear. Fail to make the payments, and the bank will take possession of your house, which is collateral for the loan.
What’s a typical model for a mortgage?
The most popular mortgage choice among homebuyers is a so-called “conventional loan” — a mortgage that isn’t backed by the government, and is instead offered by a bank, credit union or online lender.
Terms for these loans can come in different lengths and structures, but lenders typically offer 15-year and, most commonly, 30-year mortgages. You pay a fixed interest rate throughout the life of the loan, and the longer the term, the lower the monthly payments.
The rate you pay on a mortgage depends on factors such as your credit score, employment history and level of debt as it compares to your income. And even then, different lenders may offer you different deals.
Aren’t mortgage rates high right now?
The rate that lenders charge for mortgages is related, among other factors, to short-term interest rates set by the Federal Reserve. As the Fed has steadily hiked rates in an effort to cool the economy and tamp down on inflation, the average mortgage rate has climbed.
The average rate on a 30-year fixed-rate mortgage is 7.3%, up from a December 2020 low below 3%, according to Bankrate.
That may seem dire to millennial and Gen Z homebuyers who saw friends purchase property at ultralow rates during the pandemic.
What’s a normal down payment?
Financial experts typically recommend a down payment worth 20% of the home’s purchase price, but that’s not always realistic.
In fact, the median down payment for all homebuyers is 13%, according to a 2022 report from the National Association of Realtors. That drops to 10% for buyers between ages 32 and 41 and to 8% for those 23 to 31.
If you have a conventional mortgage and make a down payment of less than 20%, you’re typically required to buy private mortgage insurance, a policy that protects your lender in the event that you’re unable to pay your mortgage.
On conventional mortgages, once you’ve built 20% equity (i.e. the amount you still owe on the home is 80% or less of its value), you can ask your lender to cancel your PMI. By law, the insurance must automatically terminate when your loan balance reaches 78% of the original value of your home.
Are there mortgages designed for people with less cash and lower credit scores?
Certain loans backed by the government are aimed at borrowers who may have lower credit scores and face more difficulty putting together a down payment. These include USDA loans, which apply to those looking to buy homes in rural areas, and VA loans, which are available to eligible U.S. military members.
Among the most popular of these government-backed options: mortgages insured by the Federal Housing Administration. While conventional mortgages often require borrowers to have a FICO score of at least 620, FHA loans are available to borrowers with a score of 580 or above if you’re making the minimum 3.5% down payment, or 500 and up if you’ve put down 10% or more.
Similar to PMI for conventional mortgage borrowers, FHA loans come with a mortgage insurance premium. It includes an upfront payment equivalent to 1.75% of your loan plus an annual payment that lasts the entire term of your loan.
Financial researchers, including those at the Urban Institute, have explored whether borrowers with low down payments would come out ahead paying PMI or the premiums on an FHA loan, but whether one or the other makes sense for you will come down to your unique financial situation. Generally, they found, PMI becomes a more attractive deal for those with higher credit scores.
Any other types of mortgages I’m likely to hear about?
Given the recent movements in interest rates, you’re likely to hear about adjustable-rate mortgages, which come with a rate that fluctuates depending on market conditions. ARMs start with a fixed interest rate for a set amount of time, which is typically lower than the rate on a fixed-rate mortgage. But after the set period, the rate can change — sometimes in your favor, sometimes not.
Under a so-called 5/1 ARM, the introductory rate lasts five years and then adjusts every year thereafter. The introductory rate on such loans is currently 6.26%, according to Bankrate.
That’s no huge bargain over a 30-year fixed rate mortgage. Plus, with an ARM, you sacrifice the stability of knowing exactly what your payment will be.
Even if you expect rates to fall, there’s no way of really knowing. An ARM may make sense for someone who knows they’re going to sell when the adjustable rate kicks in. But it’s a risky move for the average homebuyer — especially someone who may have trouble making payments if the rate bounced.
Call us at (480) 205 2234 to get more information on mortgage rates and current trends. |
