You’re thinking about buying a home and don’t want to read through a thick book about mortgages. This article provides some general home loan basics to get you started.
Deciding to buy a home and obtain a mortgage is a serious decision with significant responsibilities. Not only must you spend money upfront to obtain your loan, you’ll be entering (or increasing) your debt. You’ll also be responsible to pay a large monthly payment. Hence it is important that you choose wisely what loan to get and where to get it.
You’ll want to understand some basic terms so that you can better compare mortgage options: rate, APR, closing costs, Mortgage, monthly payment, fixed, and ARM.
First, what’s a mortgage? A mortgage is a loan used to either buy a property or to pay off an existing mortgage loan. The property itself becomes the collateral. In other words, if the borrower defaults on the mortgage, then the mortgage owner has legal claim to the home and can take possession of it.
The term “rate” refers to the percentage used in calculating the amount of interest you’ll pay for your loan. The interest is essentially your cost for borrowing money. If the interest rate remains the same throughout the loan term, then the mortgage is considered a “fixed-rate” loan. On the other hand, if the rate can change, then the mortgage is called an adjustable rate mortgage or an ARM.
In addition to interest, there are additional costs to borrowing money for a home. These fees might include paying for the loan application, checking your credit history and scores, underwriting (seeing if you qualify for a specific loan program), title search and insurance, having the property’s value appraised, loan origination, etc. All together these fees are called “closing costs”.
While the interest rate is an important number, by itself it is insufficient for comparing lenders. This is because lenders and brokers can charge different fees, making a loan from Lender A actually less expensive than from Lender B, even though it has a higher interest rate. In order to help provide a number that can be compared across lenders, the government has regulated that closing costs be added to the loan amount to determine what’s known as the Annual Percentage Rate or APR.
The total monthly payment, also known as PITI, is another important measurement to take into account when choosing a loan. The PITI includes principal (P), interest (I), property taxes (T), hazard or homeowner’s insurance and mortgage insurance (the second “I”), and HOA dues. When mortgage insurance is taken into account, loans with a higher interest rate might actually have a lower monthly payment than loans with lower interest rates.