It’s My Home and I Need it Now!

The joys of owning a home. As a part of the American Dream, buying a house comes with a book-long list of new terms homeowners should know about. Enjoying home is the top priority, but hey, someone has to pay the bills around here! That’s where the mortgage comes into play. Today’s Money Monday newsletter will discuss what a mortgage is, how it’s paid, why it exist, and other adulting information. Enjoy.

What is a Mortgage?

A mortgage is a loan used to purchase real estate like land, a house, or other physical property. Similar to a normal loan, the borrower receives a lump sum of money upfront, uses the money to purchase property, then repays the lender back with interest over time. If the borrower fails to repay the lender, the lender may foreclose on the borrower forcing them to sell in order to recoup their loan.

How Do I Get a Mortgage?

The first step towards getting a mortgage is talking to a mortgage lender. The process begins by filling out an application about your income, debt, and other financial history. After the lender reviews your application, they will give you an approval up to a certain loan amount.

Example: John Smith wants to buy a home. He fills out an application, submits the necessary documents, and gets approved for a mortgage. The lender tells John Smith that he is approved for a loan up to $300,000. This means that the financed portion of the sale (Sale Price - Down Payment = Loan Amount (financed portion)) cannot exceed $300,000 for John Smith. If the home he wants is $350,000, he will need to put down at least $50,000 in cash to qualify for this purchase.

How is My Loan Amount Determined?

A lender’s top priority is to figure out what amount of money a borrower can safely pay back the bank each month. They do this by taking your income minus your debt to determine a “true income”. Let’s say your income is $5000 a month with $500 a month debt payments. Your true income would be $4500. The lender will then determine an amount below $4500 that you are capable of paying each month towards a mortgage. At the most, your mortgage payment will be 45% of your “true income”.

Depending on the current interest rate, the lender will give you a loan amount that becomes a monthly payment below 45% of your true income.

Why Do Interest Rates Affect Mortgages?

Interest is the extra money lenders charge borrowers for well, borrowing. The higher the rate, the more “extra money” a borrower is repaying the lender. Because of this, rates directly affect a monthly mortgage payment. In the two images above, you can see how the monthly payment is influenced by the interest rate alone. Even a small 2% difference can cost a homeowner 500 extra dollars a month.

What Type of Mortgages Exist?

Fixed-Rate Mortgage

Most mortgages within the United States are 30 year fixed-rate mortgages. 30 years refers to the time it will take to repay the loan when making proper payments on time each month. Fixed-rate means the interest rate you have when the mortgage starts will remain for the entire mortgage repayment period. However, you may “refinance” the loan down the road to a different rate if you choose to. This often happens when interest rates drop significantly lower than your mortgage’s initial interest rate.

Note: Fixed rate mortgages don’t have to be 30 years. Some are 5,10, and up to 40 year terms.

Adjustable-Rate Mortgage (ARM)

Adjustable-rate mortgages get a bad name as they were (sorta) responsible for the housing crash of 2008. Although the main culprit of the crash were lenders giving mortgages to people who couldn’t afford them, ARMs were usually the loan products given out to those individuals.

Adjustable-rate mortgages have a fixed interest rate for a certain amount of time, then will fluctuate based on the future interest rate. Usually there is a limit to how much the interest rate can change in a set period of time. For example; a 5/1 adjustable-rate mortgage means the interest rate is fixed for the first 5 years, then will fluctuate after the five years is up until the loan is fully repaid.

ARMs start with lower interest rates than fixed-rate mortgages to keep the initial cost down, but in a way you are gambling that your rate won’t change significantly after the initial fixed-rate period is over.

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