A mortgage is just a loan, specifically for the purpose of buying a home. There are lots of different types of mortgages, options that are offered, and details to keep track of. We’re going to cover the most common options and what they mean to you, but this isn’t a comprehensive list of everything involved in a mortgage. If you have specific questions not covered here, chat with a BrightDime coach.
A mortgage is a secured loan, meaning the home you purchase is collateral for the lender. If you fall too far behind on your mortgage payments, the lender can foreclose – taking possession of the home because you’ve defaulted on the loan.
The term of the mortgage is how long you will have to pay it back. It typically ranges from 10 to 30 years. Generally speaking the shorter the term, the lower the interest rate you’ll qualify for. I.e. a 15 year mortgage will have a lower interest rate than a similar 30 year mortgage. However, because you’re making fewer payments the shorter term mortgage monthly payments will be significantly higher than the longer term payments. If you borrow $200,000 and agree to pay it back in 15 years each monthly payment will have to be a lot more than if you agree to pay it back over twice as long in a 30 year mortgage.
The principal is the amount you’re borrowing. If you are buying a $250,000 home and make a 20% down payment of $50,000 you’re borrowing $200,000 – that’s your principal amount. But it’s not what you’ll pay back, that will be much more.
The interest rate is what determines how much you’ll pay on top of the amount you borrow. If you borrow $200,000 at 4.5% you’ll pay much less in total than if you borrow $200,000 at 6% (the exact amount will depend on other variables).
The monthly payment on the mortgage is what you will be responsible for paying every month. It is made up (usually) of both principal and interest. At the beginning of the term almost all of the payment will be interest and you won’t be making much of a dent in the principal. Over time more and more of the monthly payment will be going towards the principal. In most cases a small part of your monthly payment will go towards “escrow”, a separate account held to pay other expenses like property taxes or homeowners insurance. Not all mortgages include escrow payments and if yours doesn’t, you are responsible for making the property tax and homeowners insurance payments yourself. You may also pay something additional for private mortgage insurance (PMI) in your monthly payment if you put less than 20% down.
A feature you’ll want to check for is whether there are any prepayment penalties. A prepayment is an additional payment, on top of your scheduled monthly payments, that you can make to pay off additional principal and shorten the length of your mortgage by paying it off early. Prepayment penalties aren’t common, but if your loan has one there will be a fee or other cost associated with making additional payments.
One of the first choices will be a fixed rate versus a variable rate (often called an “ARM” for Adjustable Rate Mortgage). A fixed rate mortgage charges the same interest rate for the entire length of the mortgage. Your payments will be steady and predictable since your interest rate won’t change. An ARM, on the other hand, offers a variable rate. The introductory rate will usually be fixed for a short period of time, around 3-5 years, but will fluctuate after that. If interest rates rise you could end up paying much more in interest. ARMs often have lower initial rates than fixed rate mortgages, so they can be tempting. They can be a good choice if you know you will be re-selling the home before the low introductory rate ends, but this doesn’t apply to many people. If you are interested in an ARM, make sure to ask about interest rate maximums (a cap that sets the highest rate you’ll ever pay), how often the rates reset, and what index they are tied to – this is the reference rate that will determine your rate during the variable period.
A balloon mortgage is a type of mortgage with a very low payment, maybe even interest only, for a shorter than usual period of time, perhaps 10 years. At the end of that term the remainder of the balance is due all at once. Balloon payments can be very, very dangerous for borrowers and you should be absolutely certain you know what that very large payment will be, and that you can afford it before considering one.
A conventional loan is a term for a mortgage that meet certain standards and is not backed by any federal program. Some types of non-conventional loans are…
An FHA loan is a mortgage backed by the Federal Housing Administration. This program is designed to help first time home buyers and requires much lower down payments and is more forgiving of lower credit scores from borrowers. If you’re a veteran, or active service member the Department of Veteran’s affairs also offers a loan programs with as little as 0% down, and a similar program is available for buyers in rural areas through the USDA.
There are many more features and options available than we can list here. If you’re offered something you don’t recognize, or aren’t sure about make sure you understand it completely before accepting it.