Mortgage Basics – Your Complete Guide to Home Loans

Buying a home is one of the biggest financial decisions most people will make in their lifetime. For the majority of homebuyers, taking out a mortgage is necessary to afford the purchase price. A mortgage is simply a loan used to finance the purchase of real estate, whether it’s a house, condo, townhouse, or land. The property serves as collateral on the loan.

With mortgage rates still near historic lows, now can be an opportune time to explore homeownership. But first, it’s essential to understand the basics of how mortgages work. This comprehensive guide covers everything you need to know as a first-time or repeat homebuyer applying for a mortgage.

What is a Mortgage?

A mortgage is a secured loan used to finance the purchase of real estate. With a mortgage, you receive immediate financing to purchase the property by making a down payment and taking out a loan for the remaining amount. The home then serves as collateral on the loan until you repay it in full.

Mortgages allow buyers to purchase a more expensive property than they could otherwise afford with cash on hand. The borrower makes regular payments over a set repayment term until they own the home free and clear. A standard mortgage term is 30 years, but 15-year mortgages are also common.

How Do Mortgages Work?

Here is a quick rundown of how mortgages function:

• You apply and get approved for a mortgage loan. The lender evaluates your finances, including income, debt, assets and credit history.
• Once approved, you can start searching for homes within your preapproved price range. When you find one you want to buy, you make an offer and enter into a purchase agreement if the seller accepts it.
• You pay a down payment, typically 10-20% of the purchase price, at closing. This comes from your savings. The mortgage loan covers the remainder of what you owe the seller for the home.
• You become the legal property owner after closing. But the lender has a lien on the home until you repay the loan. You make regular principal and interest payments over a repayment term like 30 years.
• Once you pay off the mortgage in full, including all principal and interest, the home is 100% yours. The lender releases the lien.

While paying back the debt over time, you have responsibilities as a borrower. These include making monthly payments on time, keeping homeowners insurance and paying property taxes. If you fall behind on payments, the lender can foreclose on the home.

Mortgage Loan Process

Navigating the mortgage process involves several steps. Here is an overview of what to expect as a first-time or repeat homebuyer applying for a home loan:

Step 1: Check and improve your credit

Lenders evaluate your credit reports and scores to assess your creditworthiness for a mortgage. Borrowers with higher scores get approved for bigger loans and better terms. Before applying, check your credit reports for errors and work to boost your scores above 700. Pay bills on time and pay down balances to help improve your credit.

Step 2: Determine your budget

Consider what you can realistically afford in terms of monthly mortgage payments and other homeownership costs. Look at your income, debts, living expenses and savings to estimate a comfortable budget. Online mortgage calculators can help determine an affordable loan amount.

Step 3: Save for a down payment

You’ll need cash on hand for a down payment, which is typically 10-20% of the home’s purchase price. Conventional loans call for at least 3-5% down. FHA loans require 3.5% down, and VA/USDA loans need 0% down. As your down payment increases, your mortgage amount decreases along with the interest you pay over the loan term.

Step 4: Find the best mortgage lender

Shop and compare loan offers from multiple lenders. Look at mortgage rates, fees, loan types, and lender services. Get rate quotes from banks, credit unions, online lenders and mortgage brokers. Consider which lender best fits your needs and offers the most favorable loan terms.

Step 5: Get preapproved for a mortgage

Work with your chosen lender to get preapproved for a mortgage before home shopping. Preapproval provides a letter indicating how much the lender is willing to lend based on your financials. It shows sellers you are a serious buyer with financing ready.

Step 6: Search for your new home

Your preapproval letter will specify a maximum affordable price range. With financing prearranged, you can confidently search for homes listed in your price bracket, knowing what you can borrow. Consider must-haves vs. nice-to-haves and view homes in person before deciding.

Step 7: Make an offer

When you find the right home for your budget and lifestyle, move fast to make an offer before someone else does. Submit your bid with the help of your real estate agent. Negotiate the offer and terms of sale with the sellers and their agent. Avoid contingencies that complicate or weaken offers whenever possible.

Step 8: Complete the mortgage application

Provide documents your lender needs to verify your income, assets, employment, down payment funds and other details tied to mortgage eligibility. This helps them reaffirm you qualify based on underwriting standards related to debt, credit, income, loan size and collateral.

Step 9: Get home appraisal and inspection

Your lender will order a home appraisal to confirm the property value matches the amount agreed upon. Get a professional home inspection to evaluate the home’s physical condition and identify any repairs needed. Renegotiate the purchase price lower if serious issues arise.

Step 10: Close on your new home

At closing, you’ll finalize remaining paperwork, make your down payment, and get the keys! Closing costs include lender fees, prepaid taxes and insurance, title charges and more. Carefully review the projected costs spelled out on your Loan Estimate before closing day.

Types of Mortgage Loans

Many different types of mortgages are available to suit individual homebuyer’s needs and financial situations. Some of the main options include:

Conventional Loans

Conventional mortgages are common loans NOT backed or guaranteed by the government. They offer competitive rates and flexible terms if you qualify. Conventional loans are best for borrowers with good credit and stable finances. Minimum down payments range from 3-20%.

FHA Loans

FHA loans are government-insured mortgages that require lower down payments and credit scores. This makes them appealing for first-time buyers and those with limited savings or credit blemishes. Minimum down payment is 3.5% and minimum credit score is 580.

VA Loans

VA loans help eligible military members, veterans and surviving spouses buy a home with zero down payment required. Credit score requirements vary by lender but tend to be lower than conventional loans. VA loans offer competitive rates and require no monthly mortgage insurance.

USDA Loans

USDA loans are 100% financing mortgages for low- and moderate-income buyers in designated rural and suburban locales. No down payment or monthly mortgage insurance required. Credit score and income limits apply. Check eligibility for your area using the USDA Property Eligibility Site.

Jumbo Loans

Jumbo loans are mortgages that exceed the conforming loan limit set annually by the Federal Housing Finance Agency. The 2023 limit in most U.S. counties is $726,200. Jumbo loans help luxury homebuyers or those in pricier markets finance mortgages over that threshold. Requirements are stricter than conventional loans.

Fixed vs. Adjustable Rate Mortgages

When selecting a mortgage, you’ll choose between a fixed or adjustable interest rate. Each option has pros and cons to weigh.

Fixed-Rate Mortgages

Fixed-rate mortgages keep the same interest rate for the entire loan term. Because the rate never changes, your required monthly payment stays the same over the years. This predictable payment schedule makes financial planning simple. If rates fall in the future, you won’t be able to capitalize on the drop unless you refinance.

Adjustable-Rate Mortgages

Adjustable-rate mortgages (ARMs) offer lower starter rates that eventually fluctuate up or down based on market conditions. Your payment adjusts along with the rate changes. ARMs can make sense if you plan to move before the intro rate expires. Just be sure you can afford potential payment hikes when the rate resets.

What To Know for Your First Mortgage

If you’re buying your first home, here are some key tips to guide you through the mortgage process:

• Check your credit score and reports – Make sure no errors drag down your scores before applying for a mortgage. Pay down card balances to lower your credit utilization.
• Get preapproved first – Being preapproved makes sellers take your offer seriously since your financing is already arranged.
• Know your budget – Crunch the numbers to see how much house you can realistically afford based on your income, existing debts, down payment savings and other monthly expenses.
• Shop multiple lenders – Compare loan offers from lenders like banks, credit unions, mortgage brokers and online lenders. Even small rate differences can save thousands over your loan’s lifetime.
• Understand fees – Ask lenders to fully explain required fees such as origination charges, appraisal fees, title insurance and more. Ensure you can cover these closing costs.
• Lock your rate – During the mortgage process, you can choose to lock in an interest rate for a certain period of days to protect yourself if rates rise later. This comes at a small cost but guarantees your rate.
• Get educated – Read up on the mortgage process and attend first-time homebuyer classes offered by nonprofits. Knowledge helps you make smart financing decisions as a new buyer.

Refinancing Your Mortgage

Refinancing lets you swap out your current mortgage for a new loan with better terms, often at a lower interest rate. Reasons homeowners choose to refinance include:

• Lowering their monthly payment
• Shortening or extending loan term
• Switching from adjustable-rate to fixed-rate
• Tapping home equity via a cash-out refinance
• Removing private mortgage insurance (PMI) requirement

To get approved to refinance, you’ll go through a similar process as when you bought your home. The lender will evaluate your income, debts, credit scores, home value and equity. Closing costs get rolled into the new loan amount. Shop and compare refi offers from multiple lenders to find your best deal.

Be sure refinancing makes financial sense by calculating your breakeven point. This is how long it will take to recoup closing costs through savings from lower monthly payments or interest rates on the new mortgage. Avoid refinancing too frequently, as you’ll keep racking up closing costs.

Alternatives to Traditional Mortgages

If your finances don’t fit the mold for a conventional mortgage, alternatives are available, including:

• FHA, VA and USDA loans – Government-backed mortgages help buyers with lower credit scores, incomes or down payments qualify for financing.
• Subprime loans – Specialized lenders offer mortgages to applicants with poor credit or unique situations like recent bankruptcy. Rates are higher to offset added risk.
• Portfolio loans – Some community banks and credit unions provide portfolio loans for borderline borrowers they want to serve. Rates may be higher but worth it for approvals.
• Down payment assistance – Nonprofits and housing agencies offer down payment support via grants, second mortgages or loans to widen accessibility to home financing.
• Seller financing – In some cases, sellers provide financing to buyers for a portion of the purchase price secured by the home. This helps buyers with limited options qualify.
• Shared equity programs – Programs like community land trusts enable lower-income buyers to purchase below-market homes in exchange for sharing some equity appreciation when they later sell.

Don’t fall victim to predatory lending practices in your quest to secure financing. High-cost subprime mortgages paired with excessive fees or adjustable rates that quickly spike can set up borrowers to fail.

Tips for Getting the Best Mortgage Rates

Mortgage rates fluctuate daily based on bond market activity and other factors. When economic uncertainty looms, investors flock to bonds, pushing mortgage rates down. Rates trend up when confidence returns. The lowest rates go to borrowers with pristine credit, low debt, sizable down payments and strong finances. Consider these tips to help lock in the lowest rate possible:

• Shop around – Compare loan offers from multiple lenders. Even a small rate variance can save thousands over your loan term.
• Boost your credit score – Good credit saves you money. Pay down card balances and correct report errors to drive your scores higher before applying.
• Increase your down payment – Putting down 20% or more gives access to the very best rates and avoids monthly mortgage insurance.
• Lower your DTI – Pay off car loans or credit cards to reduce this key ratio lenders review when approving your loan and setting your rate.
• Check for lender incentives – Lenders offer rate discounts for setting up autopay, having accounts with them or buying discount points to buy the rate down further.
• Lock your rate – During the mortgage process, lock in an interest rate to protect yourself from hikes later during underwriting. This comes at a small cost but guarantees your rate.
• Mind the closing costs – Closing costs vary by lender. Lower fees can help offset slightly higher rates from one lender over another.

Comparing loan offers from multiple lenders almost always results in savings from the increased competition for your business. Even a seemingly small rate difference of .25% on a $200,000 mortgage saves you $30 monthly and over $15,000 in interest paid over 30 years.

Steps for a Smooth Mortgage Closing Process

Closing day can be stressful. Avoid surprises by taking these steps:

• Review your Loan Estimate closely when you get it after applying – It outlines projected closing fees you must pay including origination charges, appraisal, title insurance, government recording fees and more. Ask your lender to explain any unclear charges.
• Ensure your down payment money and closing costs are lined up and accessible – You’ll need to wire or deliver certified checks to fund your down payment and cover fees.
• Lock down homeowners insurance – Shop for quotes, choose a provider, and inform your lender so the policy can be paid at closing. Failing to have insurance lined up delays the process.
• Read documents thoroughly beforehand – Review title work, purchase agreement, disclosures and closing paperwork when your lender sends them over to ensure you understand everything and no changes occurred.
• Complete final walkthrough – Do a final walkthrough of the home right before closing to confirm no damage occurred after your offer and that all agreed upon terms and repairs were completed by sellers.
• Review your Closing Disclosure – You get this closing statement three days before closing. It shows your final loan details and precise closing costs. Compare to your Loan Estimate; major discrepancies could delay closing until investigated.
• Bring proper identification – Have your driver’s license, passport or other acceptable ID ready to present for legal reasons. Leave extra time for any issues like a mismatch between the name or address on your ID and mortgage application.
• Get to closing early – Arrive 15-20 minutes prior to your appointment. This ensures you have time to handle any last minute issues and review documents carefully before signing.

Tips for Repaying Your Mortgage

Making consistent on-time mortgage payments is essential. Consider these tips:

• Sign up for autopay – Automating payments helps avoid late fees caused by lapsed memory or delays while out of town.
• Pay biweekly – Making half payments every other week reduces interest paid over the loan. Essentially you end up making one extra monthly payment per year.
• Pay a little extra – Paying just $50-100 extra on your payment monthly makes a surprising difference in interest savings and total repayment time.
• Avoid cash-out refis – Repeatedly refinancing and tapping equity to take cash out keeps your mortgage balance higher than needed.
• Recast after prepaying – Some lenders let you recast your mortgage after a large lump sum payment to lower remaining monthly payments without refinancing.
• Monitor taxes and insurance – Make sure lender-held escrow accounts have enough set aside for these payments so they don’t fall behind, causing issues.

If facing financial hardship, contact your lender immediately for assistance options. They may allow temporarily reduced or suspended payments. You may also qualify for mortgage forbearance if your challenges stem from factors like job loss, illness or COVID-19 impacts. Acting quickly preserves your credit and prevents default or foreclosure.

To Recap

I hope this detailed guide provided you a thorough overview of mortgage basics and home loans. The mortgage process can seem daunting. Being an informed borrower is key to getting approved for affordable financing that fits your budget and financial situation.

Shopping multiple lenders, reviewing all costs beforehand, monitoring your credit, securing the best rate possible, and understanding your complete mortgage agreement sets you up for success as a homeowner. Don’t hesitate to turn to trusted pros like real estate agents, attorneys and financial advisors for guidance along the way.

Frequently Asked Mortgage Questions

What credit score is required for a mortgage?

Minimum credit scores for mortgage approval range from 500-620 but vary by loan type. The higher your score, the better the rates and terms you can qualify for. Conventional mortgages typically require a minimum score in the 620 range, while government-backed FHA and VA loans allow scores as low as 500-580.

How do I qualify for a mortgage?

To qualify for a mortgage, lenders evaluate your credit, income, assets, down payment funds and debts. You must demonstrate the ability to repay the loan responsibly based on factors like your employment history, monthly obligations and discretionary income. Each lender sets its own precise underwriting standards within general market guidelines.

How much house can I afford?

Lenders want your total monthly debt payments, including the new mortgage, property taxes, insurance, HOA dues, and other obligations, to total no more than 43% of your gross monthly income. This debt-to-income ratio helps determine the maximum affordable mortgage loan size and house price range for your budget. Online mortgage calculators can estimate this.

What are mortgage rates today?

Mortgage rates change daily based on bond market activity, inflation reports, the Federal Reserve’s rate policy moves, and more. Over the last year, the 30-year fixed-rate mortgage has ranged from below 3% up to almost 7%. To find the most current mortgage rates from various lenders, use Bankrate’s mortgage rate comparison tool.

How much are closing costs on a mortgage?

Closing costs range from 2% to 5% of your mortgage loan amount. These one-time fees cover items like the lender’s origination charge, appraisal fee, title insurance, taxes and more. Closing costs vary based on your state, loan size, lender and other specifics of your transaction. Your Loan Estimate breaks down estimated costs.

How long does it take to close on a house?

It takes approximately 43 days on average to close on a home once you have an accepted offer, according to Freddie Mac. The closing timeline stretches longer if anything delays the mortgage underwriting process, like appraisal issues, credit problems or missing documents from you. Aim to get preapproved a few months before making offers to allow ample time.

In another related article, The First Time Homebuyer’s Guide to FHA Loans