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In addition to finding the right home in the right location, obtaining a mortgage is critical when purchasing unless you can pay in cash. For a first-time buyer, the many different financial options can seem overwhelming, so you’ll want to take the time to learn the basics of home financing to save a significant amount of time and money.
A house payment calculator is helpful for getting an idea of how much house you can afford, but going beyond by doing a little research is essential too.
A Loan or a Mortgage?
A mortgage is a loan, but it’s a type of loan only used to finance a property. All mortgages are secured loans which means the borrower is promising collateral to the lender in the event they default (stop making payments). The home is the collateral when taking out a mortgage. If you stop making your monthly payments, the lender can take over possession of your home, which is called foreclosure.
Applying for Home Financing
Securing a mortgage is a big financial commitment and a time-consuming process. It’s worth being patient by researching lenders to see which offer the best mortgage rates as the interest rate you’ll pay determines the loan costs over time.
Mortgages rates are either adjustable or fixed. An adjustable-rate mortgage is a loan with a rate that can vary, so you might start out paying a very low interest rate but then see it climb in the future, resulting in higher monthly payments. A fixed mortgage is paid at the same rate over the life of the loan, providing the security of knowing the ate will never change, which means your payments won’t go up.
What You’ll Need to Obtain a Mortgage
Securing a mortgage requires a down payment, good credit, and a low debt-to-income ratio. A score of 670 or above is considered good (or better the higher it gets). Ideally, you’ll want it to be at least 740. You might qualify for a home loan with a lower score, but that usually means a high interest rate and a higher monthly payment.
If any errors on your credit report are lowering your score, get them corrected first to raise it. It pays to boost your score in every way you can before securing a mortgage, so you might want to pay off as much of your existing debt as possible. Needless to say, paying all your bills on time is vital too.
The amount of debt you have affects your credit score. This is referred to as your debt-to-income ratio, which should be no more than 36 percent. For example, if you bring home $5,000 a month, your existing monthly debts should not be more than $1,800. Avoid making large purchases requiring a loan, such as a new car, which could increase your debt to the point that your loan request is declined.
Types of Mortgages
There are multiple types of mortgages you should be familiar with; take time to research the following.
- Conventional mortgages
- Jumbo mortgages
- FHA loans
- VA loans
- USDA loans
When a mortgage is finalized, you’ll have to pay a number of fees known as closing costs. These fees typically equal 2 to 5 percent of the mortgage value. They can be paid as a one-time expense, or they can be rolled into your mortgage, paid overtime (with interest).