If you are considering purchasing your first home, the process may be overwhelming. One of the key aspects is financing your home purchase. Let’s review mortgage basics and put you in a better decision making position.
Part 1 of 8
There are lot of terms thrown around in the mortgage industry like escrow, pre-qualification, pre-approval, fixed-rate, adjustable-rate, etc. All these can serve to confuse and overwhelm a home buyer, but it does not have to be confusing or difficult.
Let’s start with what a mortgage is.
A mortgage is simply a type of loan. These loans, mortgages, are secured by real estate – the home you are buying, for example. Like any loan, a mortgage is a promissory note, meaning you are promising to pay back the loan. A lender of a mortgage secures their loan to you by having a legal claim to your property in case of a default on the mortgage. In case of failure to pay the mortgage within the terms of the loan agreement, the lender can take back the property in a process called foreclosure.
What is included in monthly mortgage payments? PITI – Principal. Interest. Taxes. Insurance.
Principal is the amount borrowed, or amount financed, to purchase the property.
Interest is how much the lender charges to borrow the money for either the purchase of the home or refinancing of an existing mortgage or loan. You may see or hear “APR” used to quantify how much the loan or mortgage costs you.
Taxes refers to the property taxes you will be paying to your local city or municipality, and maybe county. These will be included in your mortgage.
Insurance to cover your home from damage. Damages covered may include fire or natural disasters. PMI may be included in this.
PMI is Private Mortgage Insurance, which is usually required on loans where the down payment is less than 20% of the purchase price. For example, if the home purchase price is $100,000 and you make a down payment – your own money, not the borrowed money – of $10,000, then you made only a 10% down payment and PMI may be required. This is additional insurance for the lender of the mortgage and the PMI will typically go away once you reach or exceed the 20% equity threshold.
Home equity is the value of your ownership of the home. It includes the total amount of payments – down payment + principal payments – you made towards your home. For example, if you made a $10,000 down payment, plus made ten $1,000 principal payments on a home valued at $100,000, your equity would be $20,000 (10,000 + (10 * 1,000) = 20,000), or 20%.
Your mortgage may also include payments or fees for a homeowner’s association if your property is part of an HOA. This may likely show up if purchasing a condominium.
When is a mortgage not needed?
A mortgage is required only when you are not paying for the home out of your own pocket. In other words, if you have $250,000 in your checking account and you can write and cover a check to pay for a $250,000 or under home, then you do not need a home mortgage.
However, even if you do have the funds to purchase a home without a mortgage, it may make financial sense to take a mortgage and apply your money towards an investment vehicle. This is a discussion for a financial advisor, but consider the very basic concept: If a mortgage costs you 6% interest – how much you are charged for the loan – and you can invest your own money in an investment that will earn you 10%, theoretically you will be ahead by 4% – You earn 10% minus the 6% cost of the mortgage = 4%.
Again, a discussion about investment strategies should be between you and your accountant, financial advisor or other investment professional. The above example is a very basic and hypothetical illustration. There are many other considerations when evaluating investment strategies like taxes, opportunity costs, etc.
A mortgage is simply a name of a type of loan that is secured by a real estate property. There are residential and commercial mortgages. What we reviewed in this article focused primarily on residential mortgages.
If you are in the home-buying planning stage, now would be a great time to talk to a mortgage professional, either a mortgage banker or mortgage broker. What is the difference between a mortgage banker and broker? Read this article to understand, “What is a Mortgage Broker?“
If you are in Connecticut or Massachusetts, and in the market for a new home, contact us and let’s review your options. As a mortgage broker, we have access to a wide range of mortgage products and can find one that works for your unique situation.
Use our Quick Quote form on our homepage or our Get Started form. Call us at (860) 285-0635 or email Mark or Samir (MHarrington@HorizonHomeMtg.com / SDoshi@HorizonHomeMtg.com), and we will connect you with any of our friendly, experienced team members.
“Your Mortgage Partner for Life”
If you liked this article, continue with the next article in our “Mortgage Basics” series and learn about escrows.
If you know someone who would find this article helpful, please share it with them.
Join our online community by following us on Facebook!