Mortgage Basics

What every property buyer needs to know

Unless you’re in the enviable position of being able to pay for a property outright, you’re likely going to become the proud holder of a mortgage for whatever property you’re buying.

In the simplest of terms, a mortgage is a type of loan used to purchase or maintain a piece of real estate. This could be a house, a condo, an office building, a warehouse, or even a plot of land. 

The basic rules of a mortgage are that the borrower (that’s you) agrees to pay the lender back through regularly scheduled payments over a specified period of time, typically 10 to 30 years. Those payments include the amount of money borrowed, known as the principal, plus interest, taxes, and insurance.

While the cost of taxes and insurance are largely out of your hands, you do have a bit of control over the amount of interest you pay based on the type of mortgage you get and, thus, how much your monthly payment is.

The two most common types of mortgages are fixed rate and adjustable rate. Here’s how they work and differ:

Fixed-rate mortgage: With this type of mortgage, you lock into a ‘fixed’ interest rate for the term of your mortgage. The advantage of a fixed-rate mortgage is that you know what your monthly payment will be. However, if interest rates drop during the term of your loan, you can refinance to take advantage of the lower rate. Just be advised that refinancing comes with its own costs. The general rule of thumb is that refinancing makes sense only if you can reduce your interest rate by 2% or more.

Adjustable-rate mortgage (ARM): As the name suggests, the interest rate on this type of mortgage adjusts or varies over time based on the market. While ARMs typically offer a  lower initial interest rate than fixed-rate mortgages, meaning your monthly payment is as low as possible, the rate can (and will) fluctuate over time. If you need to stick to a tight monthly budget, an ARM is probably not for you. But if you have some flexibility (mentally and financially), an ARM will allow you to take advantage of any drops in interest rates. Another advantage of ARMs is that they’re generally  easier to qualify for than fixed-rate mortgage thanks to the initial lower monthly payments.

Like fixed-rate mortgages, you can refinance an ARM at any time. Getting the best possible interest rate is one way to bring your monthly mortgage payment down. The other way to do that is by making a sizable down payment. The bigger your down payment, the smaller the amount of principal you must pay back and the less interest you’ll accrue on that principal over time.

For most people, the gold down payment amount is 20% of sale price. The reason 20% is key is that if you put down less than 20%, you’ll have to pay for private mortgage insurance (PMI) on top of each monthly mortgage payment. While you’re paying for it, PMI compensates the lender for the risk they assume by extending you a loan while receiving a smaller down payment from you. The good news with PMI is that it goes away when your mortgage balance drops to a certain percentage of your home’s value.

Once you’ve wrapped your head around the different options for and the factors that impact your mortgage options, you want to work with your lender to get prequalified for a mortgage. Again, all this should be done before you begin looking at homes. A free service from mortgage lenders, prequalification is when your lender evaluates information you provide on your income, assets, and credit score to give you an estimate on how much you can borrow and what your interest rate might be. This allows you to keep your search focused on what you can truly afford.

It’s important to note that preapproval is NOT a guarantee that you’ll be approved for a mortgage; it’s more of an estimate. However, you can—and likely should—get preapproval.   

Getting preapproval requires you to complete an official mortgage application and provide your lender with the necessary documentation and permission to perform extensive credit and financial background checks. Because of the additional work that must be completed to provide preapproval, some lenders charge a fee for the service. However, the benefit of preapproval is that it speeds up the buying process, as the seller knows that the offer is serious a serious one, and it gives you a bit of leverage over other non-prequalified potential buyers.

To learn more, you can Request a Meeting on our Mortgage section of the website.

DISCLAIMER: This article is meant for educational purposes only and is not intended to be construed as financial, tax, investment or legal advice.