What Is A Mortgage and How Does It Work
A mortgage is an agreement between a lender and a borrower (buyer), that allows the buyer to take ownership of the home, while making monthly payments to the lender. Mortgage loans are used to buy a home or to borrow money against the value of a home you already own. There are numerous types of loans available, with a variety of options related to the associated fees, interest rates, terms, programs and more.
There are seven primary things to look for in a mortgage:
- The interest rate and any associated fees
- The closing costs of the loan, including the lender's fees
- The Annual Percentage Rate (APR)
- The type of interest rate and whether it can change (is it fixed or adjustable?)
- The loan term, or how long you have to repay the loan
- Whether the loan has other risky features, such as a pre-payment penalty, a balloon clause, an interest-only feature, or negative amortization
- Discount Points (the cost associated with obtaining a lower interest rate or “buy-down”)
Focus on a mortgage that is affordable for you given your other priorities, not the maximum amount for which you qualify.
Lenders will tell you how much you are qualified to borrow - that is, how much they are willing to lend you. There are numerous online calculators that allow you to compare your income and debts and come up with similar answers. But how much you could borrow is very different from how much you can afford to repay without stretching your budget for other important items. Lenders do not consider all your family and financial circumstances. To know how much you can afford to repay, you'll need to take a hard look at your family's income, expenses and savings priorities to see what fits comfortably within your budget.
Don't forget other costs when coming up with your ideal payment.
Costs such as homeowner's insurance, property taxes, and private mortgage insurance are typically added to your monthly mortgage payment, so be sure to include these costs when calculating how much you can afford. You can get estimates from your local tax assessor, insurance agent and lender. Knowing how much you can comfortably pay each month will also help you estimate a reasonable price range for your new home.
Learn more about all the costs associated with getting a mortgage
Mortgages are complex and getting a better deal on one part of the mortgage often means paying more elsewhere. For example, one mortgage may have a lower interest rate, but higher closing costs than another offer.
Consider your choices for paying for these costs
All mortgage loans include some costs that you pay upfront, at the time of closing, and some you pay over time, in your monthly payment. You have some choices for how much you pay, and when:
- If you want to lower your interest rate, you can pay discount points. Points, as they are often referred to, are money you pay upfront to your lender in exchange for a lower interest rate. Points increase your closing costs and are typically only a good idea if you plan on staying in the home for many years.
- If you want to reduce your closing costs, you can ask to receive lender credits. Lender credits are money you receive from the lender to offset your closing costs. You agree to pay a higher interest rate in exchange for an upfront rebate that is applied to your closing costs.
- You can do neither. You pay all of your closing costs out-of-pocket up front and get an unadjusted interest rate.
Points and credits let you make tradeoffs between paying more upfront or paying more in your monthly payments
What’s right for you depends on your situation, how long you expect to be in the home, how much cash you have available for closing, and the lender's specific rates.
You can always shop lenders and compare closing costs (and you should)
Comparison shopping for loan offers can help you save money at closing and every month. Be sure to get prequalified before you start looking for a home, so that you’ll know how much home you can afford and to be ready to act quickly when that perfect home comes along. Here are a few important considerations:
The Annual Percentage Rate (APR) helps you compare options.
The APR is a helpful tool for comparing loan options with different interest rates and fees. It takes into account both the interest rate and fees, so you can see which loan is less expensive over the full loan term.
You may see a "no closing cost loan" advertised, but that doesn't mean the closing costs are free.
In most cases, you still pay for the closing costs in a “no closing cost” loan. Typically, you pay in one of two ways, and either option may be worth considering if you’re short on cash for closing:
The costs are rolled into the loan amount or sales price, increasing the total loan amount to cover the closing costs.
The larger loan means you pay more interest charges over time. In some cases, the increased loan amount can mean you pay a higher interest rate as well.
The costs are rolled into the interest rate.
The lender is providing a rebate, known as a lender credit, to cover the closing costs. You pay a higher interest rate for a loan with credits than for a loan without credits.
Sometimes, the seller may offer to pay some of your closing costs
You would need to negotiate directly with the seller – not the lender – for the seller to pay some of the closing costs. Depending on the particular market in your area, sellers may be more or less willing to pay for some of your closing costs.
Mortgage Terms In Plain English
Annual Percentage Rate (APR)
Compared to an interest rate, an annual percentage rate (APR) is a broader measure of the cost to you of borrowing money, expressed as a percentage rate. This is in contrast to the interest rate, which is the cost you will pay each year to borrow the money, expressed as a percentage rate. The interest rate does not reflect fees or any other charges you may have to pay for the loan. The APR, on the other hand, reflects not only the interest rate but also any points, mortgage broker fees, and other charges that you pay to get the loan. For that reason, the APR is usually higher than the interest rate
Amortization means paying off a loan with regular payments (installments) of principal and interest, so that the amount you owe goes down with each payment over the full term of the loan.
An appraisal is a written document that shows an appraiser’s opinion of how much a property is worth (or “value”). The appraisal gives you useful information about the property. It describes what makes it valuable and may show how it compares to other properties in the neighborhood. An appraisal helps assure you and your lender that the value of the property is based on consistent information, not just the seller’s opinion. When you borrow money to buy or refinance a home, your lender may need to get a new appraisal and will require you to pay for it. Your lender may also use other ways to check the value of the home. For a typical home loan (that is, a loan secured by a first mortgage on your residential real estate), you are entitled to receive a copy of appraisals and opinions of value your lender gets. Remember, receiving a particular value from an appraisal does not change your agreed upon price, and is merely an opinion based on an appraisers best efforts.
Cash to Close
Cash to close is a simple concept, but the calculation involves quite a few elements. Simply, it is the total amount a buyer needs to close on the house and bring to closing. This includes the down payment and pre-paid items like escrow funds, title insurance or attorney fees, as well as money for other costs associated with closing on your home (“closing costs”). Cash to close is the entire amount you will need on the day of closing your mortgage loan and can vary dramatically, depending on the program and lender you choose.
Closing costs are one of the elements in a buyer’s “cash to close.” They can include a wide range of items: mortgage origination fee, title search expense, credit report fee, appraisal fee, recording fees, home inspection fee, mortgage tax, survey, mortgage insurance premiums, and other items. Please note that closing costs do not include down payment or prepaid items like escrow funds – these are part of your overall “cash to close.”
A Closing Disclosure is the official form that provides final details about the mortgage loan you have selected. It includes the loan terms, your projected monthly payments, and how much you will pay in fees and other costs to get your mortgage (closing costs). The lender is required to give you the Closing Disclosure at least three business days before you close on the mortgage loan. This three-day window allows you time to compare your final terms and costs to those estimated in the Loan Estimate that you previously received from the lender. The three days also gives you time to ask your lender any questions before you go to the closing table. This is required by law, although, in certain instances you may be able to waive this 3-day period. Discuss with your lender or closing agent or attorney for more details.
A conventional loan is any mortgage loan that is not insured or guaranteed by the government (such as under Federal Housing Administration, Department of Veterans Affairs, or Department of Agriculture or “USDA” loan programs). Conventional loans typically cost less than FHA loans but can be more difficult to get. There are two main categories of conventional loans: Conforming and non-conforming. Conforming loans have maximum loan amounts that are set by the government. Non-conforming loans are less standardized. Eligibility, pricing, and features can vary widely by lender, so it’s particularly important to shop around and compare several offers.
The down payment is the initial portion of the total amount due for the mortgage. It shows the lender that you can save money and helps ensure the lender that you can afford the home. It is usually made by wire transfer or cashier’s check at the time of closing. There are many options for making down payments. The amount of your down payment will vary by the loan you choose and the lender’s requirements. Generally, the larger the down payment you are able to make, the lower the interest rate you will receive and the more likely you are to be approved. If you cannot make a down payment of 20 percent, no problem - lenders usually require you to purchase mortgage insurance (MI). There are many types of mortgage insurance, so be sure to ask you lender for options that make the most sense for you.
An escrow account is an account set up by your mortgage lender to pay certain property-related expenses, like property taxes and homeowner’s insurance. Escrow accounts are not always required but are generally a good idea for many homebuyers. The money that goes into your escrow account comes from a portion of your total monthly mortgage payment. An escrow account helps you pay these expenses because you send money through your lender or mortgage servicer, every month, instead of having to pay a big bill once or twice a year. An escrow account is sometimes called an “impound” account.
Not all mortgages have an escrow account. If your mortgage loan does not have an escrow account, then you pay your property taxes and homeowners insurance directly.
Federal Housing Administration (FHA) Loan
FHA loans are loans from private lenders that are regulated and insured by the Federal Housing Administration (FHA), a government agency. The FHA doesn’t lend the money directly to borrowers; private lenders do that. FHA loans are different from conventional loans in a few ways:
- FHA loans allow for down payments as low as 3.5 percent of the total loan amount.
- They allow lower credit scores than most conventional loans.
- They have a maximum loan amount that varies by county.
Talk to your lender for more details about an FHA loan and whether if may be a good fit for your financial circumstances.
A fixed-rate mortgage is a type of loan where the interest rate is set when you take out the loan and it will not change at any point over the life of your loan term.
Homeowner’s insurance pays for losses and damage to your property if something unexpected happens, like a fire or burglary. Standard homeowner’s insurance doesn’t cover damage from earthquakes or floods, but it may be possible to add this coverage. Homeowner's insurance is also sometimes referred to as "hazard insurance." Many homeowners pay for their homeowner’s insurance through escrow as part of their monthly mortgage payment.
Interest Rate (aka “Rate”)
The interest rate is the cost of a loan you will pay each year to borrow money, shown as an annual percentage of the outstanding balance of the loan.
Each year Fannie Mae, Freddie Mac, and their regulator, the Federal Housing Finance Agency (FHFA), set a maximum amount for loans that they will buy from lender. These loan limits change annually, and in some high-cost parts of the continental United States these loan limits may be significantly higher. Mortgage loans are allowed to exceed these loan limits. These larger loans are called “Jumbo” loans. The cost of obtaining a jumbo mortgage can be higher than the cost of obtaining other loans, depending on the amount of down payment. This is a specific type of loan and may have a number of other unique characteristics, so be sure to discuss these in detail with your lender.
Lender credits are credits provided by your lender to you directly, and may lower your closing costs. These can be offered with no increase in interest rate or in exchange for accepting a higher interest rate. This is sometimes referred to as “premium pricing” by lenders. Lender credits are an important part of the mortgage shopping experience, and are always a negotiable aspect of finding the most competitive loan offer.
If you need help with your Closing Costs, sometimes, in exchange for a lender credit, you can opt to pay a slightly higher interest rate and receive additional lender credits from your lender. In this scenario, the more lender credits you receive, the higher your rate will be. Be sure to discuss all available solutions with your lender.
Loan-to-Value Ratio (LTV)
The loan-to-value ratio is the percentage borrowed compared to the lower of either the sales price or the appraised value of a home. The higher your down payment, the lower your loan-to-value ratio. Generally, lenders require borrowers to get mortgage insurance when the loan amount is between 80-100% of the sales price.
A Loan Estimate (sometimes abbreviated as “LE”) is an industry standard, informational, three-page disclosure form that you should receive within a few days of completing your mortgage application. You should receive one from each lender for which you make loan application.
The form uses clear language and design to help you better understand the terms of the mortgage loan you've applied for. All lenders are able to use the same standard Loan Estimate form. This makes it easier for you to compare mortgage loans side-by-side, so that you can choose the one that is right for you. When you receive a Loan Estimate, the lender has not yet approved or denied your loan application. The Loan Estimate shows you what loan terms the lender expects to offer if you decide to move forward. If you decide to move forward, the lender will ask you for additional financial information. Lenders are only held accountable for the figures on an actual Loan Estimate, not on any other “worksheet” that they may provide.
The Loan Estimate itself provides important details about the loan you have requested. The LE breaks down specific information, including the estimated interest rate, annual percentage rate, monthly payment, and total closing costs for the loan. The Loan Estimate also gives you information about the estimated costs of taxes and insurance, and how the interest rate and payments may change in the future. In addition, the form indicates if the loan has special features that you will want to be aware of, like penalties for paying off the loan early (a prepayment penalty) among a variety of other important topics.
A mortgage is an agreement between you and a lender, where the lender lends you money in exchange for taking an interest in your property’s title. This interest becomes void when the entire loan has been paid in full. Mortgage loans are used to buy a home or to borrow money against the value of a home you already own.
Mortgage Insurance or Private Mortgage Insurance (PMI)
Mortgage insurance protects the lender if you fall behind on your payments. Mortgage insurance is typically required if your down payment is less than 20 percent of the total loan amount. There are a variety of mortgage insurance options and requirements based on the type of loan you select. You should have a detailed conversation with your lender to determine what makes the most sense for your unique circumstances.
An origination fee is what the lender sometimes charges the borrower for making the mortgage loan. These are not required, and often negotiable. Origination fees are often expressed as a percentage of the loan amount.
Discount Points (“Points”)
Discount Points, also known as “points”, lower your interest rate in exchange for paying for an upfront fee. Discount Points let you make a tradeoff between your upfront costs and your monthly payment. By paying points, you pay more upfront, but you receive a lower interest rate and therefore pay less over time. Points can be a good choice for someone who knows they will keep the loan for a long time. Points are calculated in relation to the loan amount. Each point equals one percent of the loan amount. For example, one point on a $100,000 loan would be one percent of the loan amount, or $1,000. Two points would be two percent of the loan amount, or $2,000. Points don’t have to be round numbers – you can pay 1.375 points ($1,375), 0.5 points ($500) or even 0.125 points ($125). The points are paid at closing and increase your closing costs. Paying points lowers your interest rate relative to the interest rate you could get with a zero-point loan at the same lender but are not generally a required component of obtaining a mortgage loan.
The principal is the outstanding loan balance and changes every month over the life of the loan. For most loans, you pay a portion of both Principal and Interest throughout the life of the loan. The principal is the amount you borrowed and have to pay back, and interest is what the lender charges for lending you the money.
Principal, Interest, Taxes, and Insurance, known as PITI, are the four basic elements of a monthly mortgage payment. Your payments of principal and interest go toward repaying the loan. Amounts that cover property taxes and homeowner’s insurance may go into an escrow account, if you are required or choose to have one, to cover your property tax and homeowner’s insurance payments as they come due.
Title insurance protects your lender against problems with the title to your property, such as someone with a legal claim against the home. Title insurance only protects the lender against problems with the title. To protect yourself, you may want to purchase owner’s title insurance. Owner’s title insurance provides protection to the homeowner if someone sues and says they have a claim against the home from before the homeowner purchased it. When you purchase your home, you receive a document typically called a deed, which shows how the seller transferred their legal ownership, or “title” to their home, to you.
Title insurance can protect you if someone later says they have a claim against the home before you purchased it. Common claims come from a previous owner’s failure to pay taxes or from contractors who say they were not paid for work done on the home before you purchased it. Most lenders require you to purchase a lender’s title insurance policy, which protects the amount they lend. You may want to buy an owner’s title insurance policy, which can help protect your financial investment in the home.
The US Department of Agriculture offers a similar program to the FHA and VA, designed for low- and moderate-income borrowers in rural areas. USDA loans (also called Rural Development Loans) can be a good option for borrowers who have little available savings. They offer zero down payments and are usually cheaper than other comparable loans. There are specific geographical restrictions determined by the USDA, so even if your personally qualify, your home may not be located in an eligible area. Be sure to discuss with your lender.
A VA-backed loan is a loan offered through a program run by the Department of Veterans Affairs (VA). These programs are intended to help servicemembers, veterans, and their families buy homes. The VA does not make loans, but rather sets the rules for who may qualify and the terms under which mortgages may be offered. The VA also guarantees a portion of the loan to reduce the risk of loss to the lender. The terms for these loans can be very competitive, so if you qualify for a VA loan, be sure to discuss this option with your lender.
Down Payment Options
The Down Payment is the initial amount of money used for the purchase of a new home. The traditional thinking has been that lenders always require 20% of the sales price for a down payment, but that is not the case. There are a number of loan programs that require as little as $0 down payment. Be sure to talk to multiple lenders about all available loan programs and down payment options.
To get started, determine how much money you have to use for the purchase of your new home:
- Gather your savings and investment statements
- Add up your total available funds
- Decide how much you want to set aside for other savings goals or moving costs
- Subtract these costs from your total available funds
- The result: the amount of cash you have available to use toward the purchase of your new home
Estimate Your Costs to Close
In addition to your down payment, there are many costs associated with "closing" or finalizing your loan and home purchase. Closing costs depend on a lot of things – the price of the home you buy, your down payment amount, the lender costs, the kind of loan you choose, and the location of your new home. Since you’re still early in the process, it’s hard to make a precise estimate at this stage.
- You can make a rough estimate now, using a home price that is typical for the neighborhoods you’d like to live in. Come back and refine your estimate as you move forward and gather more information.
- Typically, closing costs (not including your down payment) range from 1.5-3% of the purchase price.
Determine Your Down Payment
It is easy to determine your maximum down payment amount. Just subtract your closing costs estimate from your available cash for closing, and the remainder is what’s available for your down payment. Remember, you will have both Down Payment and Closing Costs to pay for at closing, so be mindful about this when discussing with your lender.
Other Important Considerations
Low down payment or zero down payment options may be available to you
- There are special programs for veterans and service members, rural residents, some types of first-time homebuyers, and others. Beazer’s Choice lenders can help you determine what programs are available for you in your area.
- Individual lenders may also offer their own low- or no-down payment options.
- Low-down payment options may come at an increased cost. When you meet with lenders, ask to see multiple options and ask questions until you are comfortable.
What Are Typical Closing Costs
When you are buying a home you generally pay all of the costs associated with that transaction. However, depending on the purchase agreement or what you negotiate, the seller may end up paying for some of these costs. Typically, closing costs (not including your down payment) range from 1.5-3% of the home purchase price.
Even if you don’t pay the mortgage closing fees directly out of pocket, you might end up paying them indirectly. Sometimes, you can negotiate with the seller for a closing cost contribution towards your closing costs.
The lender may also offer to give you a credit to help with your closing costs. This credit isn’t free either. Typically, the lender will either increase your loan amount to cover these costs or charge you a higher interest rate in exchange for the credit.
Common closing fees or charges may include:
- Mortgage fees
- Appraisal fees
- Title insurance
- Recording fees and taxes
- Prepaid expenses such as property taxes, homeowner’s insurance, and interest until your first payment is due
- And others…
Be sure to review multiple Loan Estimates from multiple lenders to make sure you are getting the lowest rates and fees available. Remember, these fees often vary from lender to lender and some of them are fixed, while others are negotiable. Be sure to address this with your lenders.
Pros and Cons of Different Mortgage Program Types
A mortgage is always made up of three different elements: the loan type, the loan term and the interest rate type. Let’s take them one by one.
1) Loan Type
Mortgage loans are organized into categories based on the size of the loan and whether they are part of a government program.
This choice affects:
- How much you will need for a down payment
- The total cost of your loan, including interest and mortgage insurance
- How much you can borrow, and the house price range you can consider
Choosing the right loan type
Each loan type is designed for different situations. Sometimes, only one loan type will fit your situation. If multiple options fit your situation, try out scenarios and ask lenders to provide several quotes so you can see which type offers the best deal overall.
- Conventional – These are one of the most common loan types and can signify a variety of loan types
- FHA – These loans require lower down payments and/or lower credit scores
- VA – For veterans, servicemembers, or surviving spouses
- USDA – For low to middle-income borrowers rural, geographically restricted areas
2) Loan Term
The term of your loan is how long you have to repay the loan. This choice affects several things:
- Your monthly principal and interest payment
- Your interest rate
- How much interest you will pay over the life of the loan
In general, the longer your loan term, the more interest you will pay. Loans with shorter terms usually have lower interest costs but higher monthly payments than loans with longer terms.
There are two reasons shorter terms can save you money:
- You are borrowing money and paying interest for a shorter amount of time
- The interest rate is may be significantly lower
Tradeoffs With Loan Term Options
|Higher monthly payments
||Lower monthly payments
|Typically, lower interest rates
||Typically, higher interest rates
|Lower total cost
||Higher total cost
3) Interest Rate Type
Interest rates come in two basic types: fixed and adjustable. Which type you choose will affect a few things:
- Whether your interest rate can change
- Whether your monthly principal and interest payment can change and by how much
- How much interest you will pay over the life of the loan
Your monthly payments are more likely to be stable with a fixed-rate loan, so you might prefer this option if you value certainty about your loan costs over the long term. With a fixed-rate loan, your interest rate and monthly principal and interest payment will stay the same. Your total monthly payment can still change—for example, if your property taxes, homeowner’s insurance, or mortgage insurance goes up or down.
Understanding Adjustable-Rate Mortgages (ARMs)
Adjustable-rate mortgages (ARMs) offer less predictability but may be cheaper in the short term. You may want to consider this option if, for example, you plan to move again within the initial fixed period of an ARM. In this case, future rate adjustments may not affect you. However, if you end up staying in your house longer than expected, you may end up paying a lot more. In the later years of an ARM, your interest rate changes based on the market, and your monthly principal and interest payment could go up a lot, even double.
ARMs are described using a certain format. Most ARMs have two periods. During the first period, your interest rate is fixed and won’t change. During the second period, your rate goes up and down regularly based on market changes. Most ARMs have a 30-year loan term.
Here's how an example 5/1 ARM would work. The first number, 5, is the number of years your initial interest rate will stay fixed. The second number, 1, is the how often (in years) your rate will adjust after the fixed period ends. Common fixed periods are 3, 5, 7, and 10 years. The most common adjustment period is 1, meaning you will get a new rate and new payment amount every year once the fixed period ends.
ARMs can have other structures. Some ARMs may adjust more frequently, and there’s not a standard way that these types of loans are described. If you’re considering a nonstandard structure, make sure to carefully read the rules and ask questions about when and how your rate and payment can adjust.
Tradeoffs With Interest Rate Options
|Lower risk, no surprises
||Higher risk, uncertainty
|Higher interest rate
||Lower interest rate
|Rate does not change
||After initial fixed period, rate can increase or decrease based on the market
|Monthly principal and interest payments stay the same
||Monthly principal and interest payments can increase or decrease over time
How do I compare offers?
When you’re ready to start comparing offers, the first step is to consider what’s most important to you: Minimizing cash to close, having the lowest monthly payment, or getting the lowest total cost over 5 years. Then you want to collect all of the same information and line them all up to make an apples-to-apples comparison.
Beazer’s Mortgage Choice helps our customers quickly facilitate these comparisons. This service is exclusively available for Beazer customers who have found their perfect home.
Line up the information
Find out all the costs involved in the loan. Knowing just the amount of the monthly payment or the interest rate is not enough. Ask for information about the same loan amount, loan term, and type of loan so that you can compare the information. The following information is important to get from each lender and broker:
1) Interest Rate
- Ask each lender and broker for a list of its current mortgage interest rates and whether the rates being quoted are the lowest for that day or week
- Ask whether the rate is fixed or adjustable. Keep in mind that if interest rates go up for these loans, so do the monthly payments
- If the rate quoted is for an adjustable-rate mortgage, ask how your rate and loan payment will vary, including whether your loan payment will be reduced when rates go down
- Ask about the loan’s annual percentage rate (APR). The APR takes into account not only the interest rate but also points, broker fees, and certain other credit charges that you may be required to pay, expressed as a yearly rate.
2) Discount Points
Discount Points are fees paid to the lender or broker for the loan and are often linked to the interest rate; usually the more points you pay, the lower the rate.
- Check your local newspaper for information about rates and points currently being offered
- Ask for points to be quoted to you as a dollar amount — rather than just as the number of points — so that you will know how much you will actually have to pay
A home loan often involves many fees, such as loan origination or underwriting fees, broker fees, and settlement (or closing costs). Every lender or broker should be able to give you an estimate of its fees. Many of these fees are negotiable. Some fees are paid when you apply for a loan (such as application and appraisal fees), and others are paid at closing. In some cases, you can borrow the money needed to pay these fees but doing so will increase your loan amount and total costs. “No cost” loans are sometimes available, but they usually involve higher rates.
- Ask what each fee includes. Several items may be lumped into one fee
- Ask for an explanation of any fee you do not understand
4) Down Payments and Private Mortgage Insurance
Some lenders require 20 percent of the home’s purchase price as a down payment. However, many lenders now offer loans that require less than 20 percent down — sometimes as little as 0 percent on certain loans. If a 20 percent down payment is not made, lenders usually require the homebuyer to purchase mortgage insurance (MI) to protect the lender in case the homebuyer fails to pay. Ask about the lender’s requirements for a down payment, including what you need to do to verify that funds for your down payment are available.
- Ask your lender about special programs it may offer.
If MI is required for your loan
- Ask what the total cost of the insurance will be
- Ask how much your monthly payment will be when the MI premium is included
Obtain the Best Deal
Once you know what each lender has to offer (after you receive a Loan Estimate), negotiate the best deal that you can. On any given day, lenders and brokers may be able to offer different prices (interest rates or fees) so make sure they put their best offer forward.
Have the lender or broker provide all the costs associated with the loan via a formal Loan Estimate. Then ask if the lender or broker will waive or reduce one or more of its fees or agree to a lower rate or fewer discount points. You’ll want to make sure that the lender or broker is not agreeing to lower one fee while raising another or to lower the rate, charging discount points, etc.
There’s no harm in asking lenders or brokers if they can give better terms than the original ones they quoted or than those you have found elsewhere.
The Cost of Home Ownership
There are several different kinds of costs you pay when taking out a mortgage. Some of these costs are directly related to the mortgage – collectively, they make up the price of borrowing money. These costs are the ones you should focus on when choosing a mortgage.
Other costs, such as property taxes, are often paid with your mortgage, but they’re really costs of homeownership. You would have to pay them whether or not you had a mortgage. These costs are important in deciding how much you can afford. However, lenders don’t control these costs, so you shouldn’t make decisions about which lender to choose based on their estimates of these costs.
You pay for a mortgage in two ways: upfront and over time, typically monthly. When choosing a mortgage, it’s important to look at both types of costs. A mortgage with a lower monthly payment may have higher upfront costs, or a mortgage with low upfront costs may have a higher monthly payment.
Your monthly payment will typically contain four elements:
- Principal – This is the money you borrowed and have to pay back. This is part of the cost of buying your home, but not a cost of borrowing money
- Interest – This is the primary cost of borrowing money, but not the only one
- Mortgage insurance – This is an additional cost of borrowing money, typically required for borrowers who make a down payment of less than 20%. This can vary dramatically by loan program, as well.
- Property taxes and homeowners’ insurance – These are costs of homeownership, not of borrowing money. They are usually bundled with your monthly payment and managed by the lender through an escrow account.
In addition, you may pay for homeowner’s association (HOA) dues. These costs are usually paid separately from your monthly payment.
In addition to your down payment, you have to pay for several different kinds of costs at closing.
- Origination and lender charges – These costs are charged by the lender for “originating,” or making you the loan. They are part of the price of borrowing money. Different lenders may choose to itemize these costs to varying degrees – it’s the overall total that matters. Common charges are labeled origination fees, application fees, underwriting fees, processing fees, administrative fees, etc.
- Discount Points or “Points” – These are a charge you pay upfront to the lender. “Points” are part of the price of borrowing money and are calculated as a percentage of the loan amount
- Third-party closing costs – These are charges for third-party services that are required to get a mortgage, such as appraisals and title insurance. You can shop separately for some of these services
- Taxes and government fees – These fees are charged by your local government. They are charged in connection with the real estate transaction but are usually not a cost of borrowing money
- Prepaid expenses and deposits – These expenses may be associated with your loan or with homeownership. Typically, you need to pay the interest on your loan between the time you close and the end of that month. It’s also common to pay the first year’s homeowner’s insurance premium and make initial deposits into an escrow account to cover future homeowner’s insurance and property taxes
What Is Mortgage Insurance and Why Is It Needed?
Mortgage insurance lowers the risk to the lender of making a loan to you, so you can qualify for a loan that you might not otherwise be able to get. If you can’t afford a 20 percent down payment, you will likely have to pay for mortgage insurance.
Mortgage insurance does increase the cost of your loan. If you are required to pay mortgage insurance, it will be included in your total monthly payment that you make to your lender, your costs at closing, or both. There are several different kinds of loans available to borrowers with low down payments. Depending on what kind of loan you get, you’ll pay for mortgage insurance in different ways.
If you get a conventional loan, your lender may arrange for mortgage insurance with a private company. Private mortgage insurance (PMI) rates vary by down payment amount and credit score but are generally cheaper than FHA rates for borrowers with good credit. Most private mortgage insurance is paid monthly, with little or no initial payment required at closing. Under certain circumstances, you can cancel your PMI.
If you get a Federal Housing Administration (FHA) loan, your mortgage insurance premiums are paid to the Federal Housing Administration (FHA). FHA mortgage insurance is required for all FHA loans. It costs the same no matter your credit score, with only a slight increase in price for down payments less than five percent. FHA mortgage insurance includes both an upfront cost, paid as part of your closing costs, and a monthly cost, included in your monthly payment. If you don’t have enough cash on hand to pay the upfront fee, you are allowed to roll the fee into your mortgage instead of paying it out of pocket. If you do this, your loan amount and the overall cost of your loan will increase.
If you get a VA loan, the VA guarantee replaces mortgage insurance, and functions similarly. With VA-backed loans, which are loans intended to help servicemembers, veterans, and their families, there is no monthly mortgage insurance premium. However, you will pay an upfront “funding fee.” The amount of that fee varies based on:
- Your type of military service
- Your down payment amount
- Your disability status
- Whether you’re buying a home or refinancing
- Whether this is your first VA loan, or you’ve had a VA loan before
Like with FHA loans, you can roll the upfront fee into your mortgage instead of paying it out of pocket, but doing so increases both your loan amount and your overall costs.
How Much Can I Afford?
The home price you can afford depends on four key factors:
- How much you can pay monthly
- How much you can pay up front in a down payment
- The kind of loan you get, for example a 30-year fixed, 30-year adjustable, 15-year fixed, etc.
- The interest rate and terms of your loan
Along with the funds available for the down payment, the amount you can pay monthly is the biggest factor in determining how much you can afford. Your total monthly home payment will include mortgage principal, interest, property taxes, homeowner's insurance, and any mortgage insurance.
Many homeowners pay their property taxes and homeowners insurance bundled into their mortgage payment. This arrangement is known as an escrow account. If you do not have an escrow account, you will still have to pay these costs. An escrow account lets you put aside the money monthly so that you won’t have a big expense during the year.
Some homes have Homeowners Association (HOA) dues. These fees vary widely depending on the amenities provided by the community. Consider these fees carefully when comparing potential homes. HOA fees are usually paid separately from your monthly mortgage payment.
When you have your budget set, and you’re ready to begin shopping for a new home, getting prequalified is a great first step. Then, when you find the home that you love, you’re able to act quickly. Click here to get the ball rolling and to get connected with a few lenders who can prequalify you.
What Are Credit Scores, and Does Shopping For A Mortgage Affect Them?
A credit score predicts how likely you are to pay back a loan on time. Companies use a mathematical formula – called a scoring model – to create your credit score from the information in your credit report. This scoring model uses information from your credit report to create a credit score. Some factors that make up a typical credit score include:
- Your bill-paying history
- Your current unpaid debt
- The number and type of loan accounts you have
- How long you have had your loan accounts open
- How much of your available credit you are using
- New applications for credit
- Whether you have had a debt sent to collection, a foreclosure, or a bankruptcy, and how long ago
Companies use credit scores to make decisions such as whether to offer you a mortgage, credit card, auto loan, or other credit product. They are also used to determine the interest rate you receive on a loan or credit card, and the credit limit.
Keep in mind there is no “one” credit score. It is important to know that you do not have just “one” credit score and there are many credit scores available to you as well as to lenders. Any credit score depends on the data used to calculate it, and may differ depending on the scoring model, the source of your credit history, the type of loan product, and even the day when it was calculated.
Usually a higher score makes it easier to qualify for a loan and may result in a better interest rate. Most credit scores range from 300-850.
What exactly happens when a mortgage lender checks my credit?
The credit check is reported to the credit reporting agencies as an "inquiry.' Inquiries tell other creditors that you are thinking of taking on new debt. A mortgage inquiry typically has a small impact on your credit score (typically 3-5 points). Inquiries are a necessary part of applying for a mortgage, so you can't avoid them.
As the section below explains in greater detail, the effect is minimal, because within a 45-day window, multiple credit checks from mortgage lenders are recorded on your credit report only as one single inquiry. Also, as a general rule, apply for credit only when you need it. Applying for a credit card, car loan, or other type of loan also results in an inquiry that can lower your score, so try to avoid applying for these other types of credit right before getting a mortgage or during the mortgage process.
Will Shopping Around for a Mortgage Hurt My Credit Score?
No. Don’t believe the myth that some lenders will tell you.
According to the Consumer Financial Protection Bureau (CFPB): “You can shop around for a mortgage and it will not hurt your credit. Within a 45-day window, multiple credit checks from mortgage lenders are recorded on your credit report as a single inquiry. This is because other creditors realize that you are only going to buy one home. You can shop around and get multiple preapprovals and official Loan Estimates. The impact on your credit is the same no matter how many lenders you consult, as long as the last credit check is within 45 days of the first credit check. Even if a lender needs to check your credit after the 45-day window is over, shopping around is usually still worth it. The impact of an additional inquiry is small, while shopping around for the best deal can save you a lot of money in the long run. Note: the 45-day rule applies only to credit checks from mortgage lenders or brokers' credit card and other inquiries are processed separately.” Click here for more details.
Additionally, you can check your own credit with no impact on your score. When you check your own credit — whether you're getting a credit report or a credit score — it's handled differently by the credit reporting agencies and does not affect your credit score. If you are applying for a mortgage and haven't already checked your credit report for errors, do so now. You can get a free copy of your credit report at www.annualcreditreport.com. If you find any errors, get them corrected as soon as possible.
A prequalification or preapproval letter is a document from a lender stating that the lender is tentatively willing to lend to you, up to a certain loan amount. This document is based on certain assumptions and it is not a guaranteed loan offer, but it lets the seller know that you are serious and likely to be able to get approved for a mortgage loan. Sellers frequently require a prequalification or preapproval letter before accepting your offer to purchase a home.
When to get a prequalification?
Lenders typically check your credit before issuing a prequalification. For these reasons, many people wait to get a prequalification until they are ready to begin shopping seriously for a home. However, getting preapproved early in the process can be a good way to spot potential issues in time to correct them.
When you’re ready, click here to get the ball rolling and to get connected with a few lenders who can prequalify you.
Find out what the lender’s preapproval process is
Every lender is different. Find out what you need to do and what documentation is required. Then follow up with the lender and provide any necessary information.
And ask the lender what assumptions they made to issue the prequalification. Is there anything about your situation that could lead to your loan being denied later on, or that could increase your interest rate or loan costs?
Some lenders base prequalifications solely on the information you provide.
Other lenders dig into the details with you now to make certain you have all the documentation you need and prevent delays and surprises later.
All lenders will require documentation at some point if you decide to apply for a loan.
It’s better to know now that you need an additional document (which could take some time to get) than when you’re about to close.
Getting a prequalification isn't the same thing as making a complete loan application
A prequalification just indicates that a lender is willing to lend to you – pending further confirmation of details. Once you make a complete loan application, the lender has confirmed your income, expense, asset, and other financial details, and has a better sense of your ability to qualify for a home loan.
There's no need to choose a lender in the prequalification stage
Getting preapproved is important because it helps you shop for a home. But at this stage, lenders aren’t in a position to give you enough information for you to make a decision about which lender offers the best deal. Getting a preapproval doesn’t commit you to using that lender for your loan.
Once you have completed the loan application process, lenders can now provide you with a “Loan Estimate,” which puts the lender on the hook for their estimated closing costs and fees. Once you have provided details to one lender, all the others are easy, as you already put this information together. This is a great way to get multiple offers so you can compare them side by side.
The Value of Comparing Offers
Buying a home is a big purchase, but it’s just that: a purchase. When it comes to spending money on our daily expenses, people have lots of options to help them find the best deal possible.
Most people shop to find the best price for laptops or appliances, but a report of recent mortgage borrowers found that almost half of don’t shop around for a mortgage when buying a home.
Failing to shop for a mortgage could cost you. Consumers who consider interest rates offered by multiple lenders or brokers may see substantial differences in the rates. For example, Consumer Financial Protection Board (CFPB) research showed that a borrower taking out a 30-year fixed rate conventional loan could get rates that vary by more than half a percent. Getting an interest rate of 4.5% instead of 5.0% translates into approximately $90 in payment savings per month. This adds up to $32,400 in monthly payment savings over the life of a typical 30 year amortized mortgage.
The CFPB survey of mortgage borrowers also found that modern mortgage borrowers:
Often fail to shop: Almost half of borrowers seriously consider only a single lender or broker before deciding where to apply.
Apply to only one lender or broker: Seventy-seven percent of borrowers only end up applying with a single lender or broker, instead of filling out applications with multiple lenders or brokers to see which can offer the best deal – to their own detriment.
Rely on information from people with something to sell: Lenders and brokers were the most popular source for information about mortgages, with 70 percent of mortgage borrowers reporting that they used them “a lot” as a source of information. Thirty percent of borrowers say they relied heavily on their real estate agent for mortgage information. While lenders, brokers, and real estate agents can be informative, they also have a stake in the transaction.
Due to the large savings available from comparison shopping, it is clear that mortgage borrowers should be shopping around. Beazer created Mortgage Choice to make this fast and easy.
Click here to read the full CFPB article.
Choosing a Fixed Rate or Adjustable Rate Mortgage
Interest rates come in two basic types: Fixed and Adjustable Rate Mortgage (ARM).
Whether your interest rate can change
Whether your monthly principal and interest payment can change and its amount
How much interest you will pay over the life of the loan
Your monthly payments are more likely to be stable with a fixed-rate loan, so you might prefer this option if you value certainty about your loan costs over the long term. With a fixed-rate loan, your interest rate and monthly principal and interest payment will stay the same.
Your total monthly payment can still change—for example, if your property taxes, homeowner’s insurance, or mortgage insurance might go up or down.
Understanding Adjustable-Rate Mortgages (ARMs)
Adjustable-rate mortgages (ARMs) offer less predictability but may be cheaper in the short term. You may want to consider this option if, for example, you plan to move again within the initial fixed period of an ARM. In this case, future rate adjustments may not affect you. However, if you end up staying in your house longer than expected, you may end up paying a lot more.
ARMs are described using a certain format.
Most ARMs have two periods.
During the first period, your interest rate is fixed and won’t change. During the second period, your rate goes up and down regularly based on market changes.
Most ARMs have a 30-year loan term.
Here's how an example 5/1 ARM would work. The first number, 5, is the number of years your initial interest rate will stay fixed. The second number, 1, is the how often your rate will adjust after the fixed period ends. Common fixed periods are 3, 5, 7, and 10 years. The most common adjustment period is 1, meaning you will get a new rate and new payment amount every year once the fixed period ends.
ARMs can have other structures.
Some ARMs may adjust more frequently, and there’s not a standard way that these types of loans are described.
If you’re considering a nonstandard structure, make sure to carefully read the rules and ask questions about when and how your rate and payment can adjust.
Pros and Cons of Fixed vs Adjustable Rate Mortgages
|Lower risk, no surprises
||Higher risk, uncertainty
| Higher interest rate
|| Lower starting interest rate
|Rate does not change
After initial fixed period, rate can increase or decrease based on the market
|Monthly principal and interest payments stay the samee
Monthly principal and interest payments can increase or decrease over time