A home is one of the most expensive things you will ever buy in your life. Most people do not opt to save the full amount of money prior to buying a house; they take out a loan. This type of loan is called a
mortgage, and it is how one finances his or her new home.
What is a mortgage?
Loans require collateral, something to be held on to by the lender as security in case the person taking out the loan defaults (fails to pay). In the case of a mortgage, the collateral is the house itself. When financing your home, it will ultimately belong to the lender until you have paid off your debt in full, including principal (the original amount of the loan) and interest. Should you default on your mortgage, the lender has the authority to take your home away from you. This is why deciding to finance your new home is such a big decision. It is a lot of responsibility for anyone.
Mortgages are generally described by their length (e.g., 15 year, 20 year, 30 year). The shorter the length, the higher your
monthly payment is going to be; you are paying off the same amount of money in a shorter time period. However, the total amount paid is lowered with shorter lengths because the total interest accrued will be less.
The amount of your monthly payment will also be determined by the size of your down payment. The more money you offer upfront to your lender, the less you will pay month to month. It is also important to note that, for non-government-insured loans, a down payment of 20% or more of the loan will not require you buy Private Mortgage Insurance (
PMI). PMI is something private lenders require as added protection for themselves, should you default on the loan.
TIP: For more information on mortgages, check out our Real Estate guide "Mortgages 101".
Categories of lenders
There are many different kinds of lenders, each with their own advantages and disadvantages. Savings and loan associations are the largest group of traditional lenders. Commercial banks also offer home loans, and this can be an advantage to the borrower (you) if you have maintained a positive relationship with your bank over the years.
Mortgage bankers and brokers are independent agents that serve as middlemen between you and a larger lending service. A mortgage banker will underwrite your loan with his or her own capital, with the goal of eventually selling the loan on the secondary market, i.e., to Freddie Mac or Fannie Mae. A mortgage broker will "shop" your loan to different lenders, working to get the most attractive terms for you.
A home loan can also be obtained through:
- Credit unions: Non-profit, member-owned credit unions will often sell the loan to a larger institution, but can offer you excellent rates.
- The homeowner: There are situations in which the original owner of the home may become your lender, especially if he or she wishes to sell the place quickly.
- Non-profit community organizations: Organizations that focus on housing and community development may offer ways for you to finance your home.
- The government: The federal government and state governments, in the interest of promoting neighborhood revitalization and homeownership in general, offer financing options as well.
APR
Between fees, non-fixed interest rates, and different terms, mortgages can be hard to untangle. How do you figure out what it is you're actually paying? Fortunately, something called the Federal Truth in Lending Act requires the lenders to disclose the annual percentage rate (APR) of your loan. The APR is like an average that takes all the factors of the loan into account to tell you, in effect, what your interest rate is each year. All those extra fees are included, so two loans for the same amount (say, $200,000) can be more easily compared with regard to what kind of deal you are getting.
Buying a home, especially your first, is one of the biggest decisions in life. It requires a lot of planning, discussion, and homework. It pays off, however, with the satisfaction of living in a place that is yours, and yours alone.