Mortgage Basics

A mortgage is not just a loan; it's a way to accomplish the dream of home ownership, an experience that is exciting, challenging, and overwhelming all at the same time.

To make the process of buying a home less stressful, make sure you have at least a basic understanding of common terms and types of mortgages before talking with a mortgage broker.

Here are some questions and answers to help you get started:

What is a mortgage?

Legally, a mortgage is a lien (a right to keep a possession owned by another person until a debt is paid off) on a property or house that is paid back in installments over a set period of time. Basically, your mortgage is your promise to pay back the money you've borrowed to buy your home.

What is the term of the mortgage?

The term of your mortgage is the amount of time you have to repay the mortgage loan. A 30-year mortgage is common. However, shorter-term mortgages, like 15 years, are also available. A longer-term mortgage may mean lower monthly payments, while a shorter-term mortgage means you'll pay the loan off faster and may have a lower interest rate.

How much is a down payment?

Most down payments are a minimum of 20 percent of the purchase price, paid in cash, and not financed by a mortgage. You can sometimes buy a property with a smaller down payment, but you may be overextending yourself and your mortgage will probably be more expensive. You'll also have to purchase mortgage insurance.

What are closing costs?

Closing costs are additional costs necessary to transfer ownership of a property. These may be paid by the buyer and/or the seller, and may include a loan origination fee, attorney's fee, appraisal fee, survey fee, and charges for obtaining title insurance. Closing costs will vary according to location and mortgage.

What are points and who pays them?

Points are a percentage of the loan amount paid at closing that may affect your interest rate. For instance, on a $90,000 loan amount, 1 point would be equal to 1 percent, or $900. If you pay points, you might get a lower rate. Sometimes, in exchange for a higher rate, the lender may pay points to offset your closing costs.

What mortgage is best for you?

This depends on your personal financial situation and how long you plan to stay in your home. Here are the two basic types of mortgages:

• A fixed-rate mortgage has an interest rate that remains the same for the life of the loan. Your monthly loan payments are locked in for the entire term of your loan, meaning your interest and principal payments won't change.
  
  This loan may be right for you if:
   
  • You're likely to stay in your house for a considerable period of time—10 years or more.
     
  • You want the security and comfort of having a set monthly mortgage payment.
     
  • You're uncomfortable with the risk of fluctuating interest rates.

  Special considerations: Fixed-rate loans generally have higher interest rates than adjustable rate mortgages—at least to start. On the other hand, you have the security of knowing that your interest rate and payments won't change.

• An adjustable-rate mortgage (ARM) has an interest rate tied to a financial index that changes over the life of the loan according to a specified adjustment period.

  For instance, common adjustment periods may be described as 3/1, 5/1, or 7/1. The first number represents the initial period of the loan during which the interest rate doesn't change. The second number refers to how often the rate can change after this initial period. So a 3/1 ARM would have a fixed interest rate for the first three years. After that, the interest rate—and your payment—could change every year.

  This loan may be right for you if:

  • You're expecting to sell your property before the end of the initial fixed-rate period.
     
  • You're expecting to refinance your property before the end of the initial fixed-rate period.
     
  • You expect interest rates to be lower in the future.

  Special considerations: ARMs are usually priced lower than fixed-rate mortgages, so your initial monthly payment may be lower. However, after the initial fixed term, your monthly payments can increase if interest rates go up.

  Be careful of interest-only ARMs. With this type of mortgage, no payment is made to the principal for a specific period of time (usually 5–10 years), meaning you're not decreasing your loan balance. Your initial payments may be lower, but can increase if the interest rate increases. And, once the interest-only period is over, your payment will definitely increase—even if the interest rate remains the same—because you'll have to pay both principal and interest.