Most Important Factors in a Home Mortgage
Mortgages are simple in theory, but have evolved to become quite intricate. A home mortgage is customized for time (i.e. 15- or 30-year), interest rate, down payment, and other variables. The final form that a mortgage takes is entirely dependent on the financial needs and capabilities of the borrower.
Below we details seven most important factors in a home mortgage loan.
1. Mortgage Type
You’ve probably heard the terminology before—fixed-rated, jumbo loan, ARM, VA, FHA, and so on. The mortgage type you enter into determines the interest rate, term length, and penalties/fees (i.e. an early payment penalty).
Here are the four main types of mortgages.
- This type of mortgage loan has an interest rate that’s tied to the market index. If rates as a whole increase, then “ARM” rates increase. ARMs are easy to get into, but can have negative consequences if mortgage rates rise.
- Unlike ARMs, a fixed-rate mortgage stays at a set interest rate. Regardless of the market, interest rates on a fixed-rate mortgage will never increase (or decrease). They’ll be higher at the outset, however, to account for this. Fixed-rate mortgages are therefore not as cheap out of the gate.
- This type of mortgage program is insured by the U.S. Federal Housing Administration. It allows lenders to offer them to high-risk borrowers. FHA mortgages are intended to allow homeowners with low cash reserves (or a bad credit score) to buy a home. As of 2020, the minimum down payment for a FHA loan is 3.5 percent.
- A veteran’s mortgage loan (aka: VA mortgage) is offered to veterans only. It typically requires a very low down payment amount (sometimes zero percent), and has much better interest rates vs. other loan programs.
With today’s mortgage rates at an all-time low, a lot of homeowners are choosing to refinance. There’s fees involved with refinancing (i.e. home appraisal), but overall it’s a good way to get a lower interest rate.
2. Interest Rate
The mortgage interest rate is arguably the most significant part of the deal. In many cases the rate you are offered is dependent on your credit score and payment history.
Example: A person with a 750-850 score will get offered much better loan terms vs. a 550-650 score. If you’re planning ahead there’s simple ways to improve your credit score.
3. Loan Term Length
The most popular home mortgage term lengths are the 15-year and 30-year loan. They’re offered in five year increments, but these two options have the most lending options and are easier customize for your situation.
In my opinion, the length of the loan itself is almost as important as the interest rate. A mortgage that’s paid off in 15-years will cost less vs. a 30-year mortgage, but is higher risk. A better alternative may be a 20-year loan without an early payment penalty.
** Your ability to negotiate terms depends on your credit score, and your down payment percentage.
4. Down Payment
The down payment is the cash that’s paid up-front upon purchase of the home. Each loan program has a minimum amount you’ll have to put down and is determined by your credit score and payment history.
Ideally a person will have enough to put 20 percent down on the value of the house, but if you have a good enough credit score you might be able to negotiate as low as 3.5 percent. If the down payment is for less than 20-percent of the purchase price, lenders will often require the borrower to take out private mortgage insurance (PMI) to lower the risk of a high-capital loan.
FYI: If you’re a veteran, the down payment can be as low as 3.5 percent (or possibly zero money down).
5. Discount Points
Think of points as miniature down payments. Each point is equal to 1-percent of the purchase price of the home.
Many lenders allow borrowers to pay one or more points. This is in addition to the down payment, and in return the borrower gets a lower interest rate on their loan. In the mortgage industry it’s commonly referred to as, “buying down the rate”.
6. Private Mortgage Insurance (PMI)
Lenders may require a borrower to take out mortgage insurance if the minimum down payment isn’t met. This is usually any down payment lower than 20 percent of the value of the home.
Mortgage insurance is paid for by the borrower and paid each month.
As of 2020, the typical PMI cost is 0.5% to 1% of the entire loan amount each year.
Example: If you’re borrowing $500,000 for your home , the PMI can be $2,500 to $5,000 per year. Divide that by twelve months and you’re looking at $208.33 – $416.66/mo. Again, this amount is in addition to your actual mortgage payment.
7. Home Closing Costs
Closing costs is the amount owed when a person sells a home or property. It’s usually 3% to 7% of the value that the home sells for.
In most cases the buyer and seller split the home closing costs.
- Broker commission
- Origination fees
- Application fees
- Home appraisal fee
- Misc. fees
There’s a lot of variables that go into buying a new home and shopping for a home mortgage. In most cases you’ll qualify for multiple loan programs, interest rates, and term length – customizing it to meet your needs is the hard part.
If you’re a first time home buyer, you should work closely with your attorney or consultant. They’ll steer you in the right direction, and explain which variables are the most important for your situation.
Example: A person who can afford a 20 percent down payment without worry may want an adjustable rate mortgage. They may also want to pay points to lower the overall cost of the loan, and negotiate an early payment penalty.
Each person’s situation is different. Before applying for loan programs, identify your financial capabilities and long term goals. This should give you an idea of the type of loan to get and which variables matter most.