Frequently Asked Questions about Mortgages
Are you thinking about buying a new home? If so, you may be considering taking out a mortgage loan to help cover the up-front purchase cost and to amortize the payments over a number of years. If this will be your first mortgage you may have some questions about this type of loan and what it entails. In this article we’ll answer some of the most commonly asked questions about mortgages.
What is a Mortgage?
In simple terms, a mortgage is a loan that is used to purchase a piece of real estate, whether it’s a house, a condo, or a piece of land. The property itself is used as ‘collateral’ or security for the loan, so if you fail to pay the loan amount plus interest the mortgage lender has the right to take back the property in order to cover your debt. There are a few key terms involved with a mortgage that you should be aware of:
The Principal is the total amount of the loan. If you take out a mortgage to buy a $300,000 home of which you put $60,000 in as a down payment, your principal would be $240,000. As you can see, you can reduce the principal by investing more in your up-front payment.
Interest is what the bank or underwriter will charge you to borrow the principal amount. The interest rate is almost always expressed as a percentage and it will vary depending on the length and terms of the mortgage.
Amortization refers to the process of paying off your mortgage debt with a fixed payment schedule. For example, you may take out a 15-year mortgage in which you pay monthly payments at a set amount. Note that early on in the repayment period most of your payment will be going toward interest. With each payment that you make, the percentage of the payment that goes against the principal amount will increase slightly.
What Affects the Interest Rate on My Mortgage Loan?
In simple terms, your interest rate is largely determined by how much risk you present to the lender. However, there are a whole host of criteria that lenders will use to determine your rate – some of which you can control, and some of which you can’t. The most important factor is your credit score or credit worthiness. For example, if you have great credit and a stable income you can expect a lower interest rate than if you have poor credit and your income is spotty. The length of the mortgage loan will also impact your interest rate, as will your decision to take out a fixed-rate or adjustable-rate mortgage. Finally there are factors like the bond markets and overall mortgage demand which can affect rates as well.
How Does an Interest Rate Affect How Much I Owe Each Month?
As you move through the life of your mortgage you will encounter times when your interest rate increases and times when it decreases. As you can imagine, an increase in rates means that you’ll be paying more on your monthly payments to make up the additional borrowing cost, and a decrease in rates means that your monthly mortgage cost will come down accordingly.
Note that if you’re on a ‘fixed rate’ period in your mortgage (see below), the interest rate is locked in and fluctuations won’t affect your monthly payment.
What’s the Difference Between a Fixed Rate and Adjustable Rate Mortgage?
When you first take out your mortgage loan, you may have to decide between a fixed rate and an adjustable rate mortgage. With a fixed rate mortgage, the interest rate is set at the time that you take out the loan and will not change over a set period of time. This can be beneficial if you believe that interest rates will rise above the fixed rate, as you’ll save money. Conversely, if you have a fixed rate mortgage and rates decrease below your rate, you’ll lose out on the additional savings.
Adjustable rate mortgages fluctuate up and down over time and this will impact your monthly payments. You’ll typically start out at a lower interest rate with an adjustable rate mortgage as opposed to a fixed rate, but if interest rates rise and stay high throughout your mortgage period you may end up paying significantly more in interest.
How Much Money Can I Get for a Mortgage?
Mortgage lenders will look at a number of different factors to determine how much they are willing to lend you to buy a home. First, the lender will look at all of the money you have coming in through work, investments, business ventures and any other sources of stable income. Then they will subtract all of the debts that you’re paying off each month, such as student loans, car payments, credit card debt, lines of credit and any other significant payments that can jeopardize your ability to make your mortgage payment on time. The mortgage underwriter or banker will also consider how much the home is going to cost, how much you’re investing in a down payment, and the amount of home equity that you have (we’ll discuss this below).
How Do I Figure out How Much Equity I Have?
Calculating your home equity is quite easy, provided you have the necessary information. Simply take the total value of your home if you sold it today and then subtract any mortgages, liens or other amounts that are owed against the property. For example, if your home is currently valued at $300,000 but you still have $100,000 outstanding on your mortgage your home equity would total $200,000. While you likely have access to the amount left to pay off on your mortgage, you might not know how much your home is worth. In this case you’ll have to do a bit of detective work by looking up nearby homes that are similar to yours that have sold recently. In a pinch you can use the average of the selling price of 3-4 homes and that should provide you with a decent estimate.
If you have other questions about mortgages or the home buying process, the team here at 8z Real Estate can help. Contact us today and we’ll be happy to consult with you and share our expertise.