There is a lot to know when it comes to financing your new home. You’ll need to get pre-approved for a mortgage, make some important financing decisions such as terms and lender.
STEP 1 – GET PRE-APPROVED FOR A MORTGAGE
The first step to buying a home should be finding out how much a bank is willing to lend you. When getting pre-approved for a mortgage, your lender will look at your credit report, income, debts and your available down payment. A mortgage pre-approval will be in writing (generally valid for 90 days) and will require you to prove your income and credit history. Pre-approvals may not include an interest rate guarantee.
Of course, a pre-approval is not a guarantee that a lender will lend you a certain amount of money for any home. Lenders want to know that the home they are purchasing with you (by lending you the money) is worth what you are paying for it. Lender generally order independent appraisals of a home before they advance the mortgage money.
Getting pre-approved will ensure that you know how much mortgage you can get, which in turn will help you know what price range of homes you should be targeting in your search. It allows you to focus your house hunting efforts, and eliminates the risk and uncertainty of financing once you find your perfect home.
STEP 2 – MORTGAGE DECISIONS
Mortgages can seem scary, especially for first-time buyers. Once you’ve qualified for a mortgage, there are some basic decisions you must make before you take possession of your home: Mortgage term, amortization, interest rate and type of mortgage. Read on to find out what all of that means and use our handy Mortgage Calculator to estimate what your payments would be.
Mortgage Term and Amortization
The mortgage amortization is the length of time (10,15 30 years) it will take you to pay off your entire mortgage. ... The longer amortization period, the less your monthly payments will be. The mortgage term and amortization period affect the amount of money you can borrow which determines the price of the home you can buy.
Choosing a mortgage term is tricky and requires you to be knowledgeable about trends in the marketplace, as well as having a sense as to the amount of risk you’re willing to endure. If you choose a 15-year loan you interest rates decrease drastically, however because of the increase monthly payment, will may qualify for less to purchase your home.
Most mortgage payments consist of four parts: principal, interest, taxes and insurance -PITI (Private Mortgage Insurance -PMI, if you put down less than 20%). This is known as a blended mortgage payment. Each payment reduces the balance owed on the mortgage by the portion of the payment that is credited to the principal. Over time, the proportion of your payment that reduces the principal balance will increase. The faster you can pay down the remaining balance, the less total interest you’ll pay. There are many ways you can pay down your mortgage faster, from accelerating your payments (e.g. paying biweekly instead of twice a month, for 26 payments per year instead of 24) to making lump sum payments on your mortgage; your lender can help define the right strategy for you.
The interest rate is one of the biggest contributing factors to how much you end up paying for your home, both monthly and over the life of your mortgage.
Interest is the cost of borrowing money. Interest rates fluctuate with the economy. The interest rate you commit yourself to at the beginning of the term can have a significant effect on the amount you pay each month for your mortgage. There are two basic types of interest rates used in mortgage products: fixed-rate and variable-rate.
Fixed-rate mortgage – Essentially, this means committing to a single interest rate that will not change for the term of your mortgage. This strategy locks in how much of your monthly payment repays the principal vs. going to interest. Fixed-rate mortgages are great in an economy where interest rates are going up, you will not have the risk of paying higher interest rates. But in an economy where interest rates are going down, you could be stuck paying more in interest than the going rate. If only we had a crystal ball…
Variable-rate mortgage – With a variable rate mortgage, the dollar value of your monthly payments is fixed for a specific term, while the proportion of interest to principal floats in relationship to the bank’s prime interest rate. If rates go up, more of your payment is applied to interest and less is applied to the principal. If rates drop, more of your monthly payment is used to pay off your principal and your mortgage is paid off sooner. Variable rate mortgages can protect you if interest rates are high at the time you arrange your mortgage; when rates fall, you’re not stuck with high-interest payments, and more of your payment is applied to the principal. But if interest rates increase, that could mean more of your payment is being applied to interest than you bargained for. In some instances, lenders will allow you to convert to a fixed-rate mortgage in this kind of situation.
Types of Mortgages
FHA mortgage – this is a mortgage loan that is insured by the Federal Housing Administration (FHA) and most common these days amongst first-time home buyers. The lender will loan you up to 96.5% of the appraised value or purchase price of the property (whichever is lower), and you generally need to come up with a minimum of 3.5% as a down payment and credit scores requirement are generally lower than conventional loans.
Conventional mortgage – this is the most common type of mortgage. The lender will loan you up to 95% of the appraised value or purchase price of the property (whichever is lower), and you generally need to come up with a minimum of 5% as a down payment.
Second (and third) mortgages – These are additional financing arrangements behind an existing mortgage, also secured by your property. Secondary financing is generally arranged at a higher interest rate and for a shorter term than the first mortgage.
STEP 3 – CHOOSE A LENDER
There are lots of kinds of lenders and mortgages out there. It’s a good idea to go to at least three lenders:
- Your own bank. They have your bank accounts, credit cards and investments so they should be motivated to give you a good rate.
- A mortgage broker. Mortgage brokers work with a lot of different lenders and will go to them on your behalf to find the best mortgage rate and terms. Usually, broker fees are paid by the banks, so it’s a good way to comparative shop without having to do all the leg work yourself.
It’s important to note that these decisions don’t have to be made before you start looking for a home; the crucial step is getting a pre-approval from a lender—then you’re ready to start the search! Details regarding term, rate and even which lender you use can be decided—and changed—after the actual purchase, all the way up until reasonably close to your closing date (the date you take possession of your new place). However, the more you understand about your options, the better prepared you will be when that magical day comes.
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