Attention first-time home buyers: If you’re thinking about buying your first home, the odds are that you’ve at least been introduced to the idea of a mortgage. However, not all mortgages are the same. What are the different types of mortgages? How do you go about getting a mortgage? Are there mortgages that are better than others?
You’ve probably heard that 20% is the gold standard for a down payment. For a first-time home buyer that can be a daunting number. Getting enough money for a 20% down payment can make buying a home seem like a distant dream. There is good news, though. For first-time home buyers, that 20% down payment number isn’t mandatory. In fact, you can often put down significantly less to get out of your rented space and into a new home.
Below we’re going answer some basic questions about mortgages, and what you can expect your monthly payments to look like.
What Is a Mortgage?
A mortgage is a secured loan used to buy a house or piece of property.
About 90% of home-buyers utilize a mortgage with a 30 year length to the loan. That is by far the most popular length. Coming in a not-so-close second place is the 15-year mortgage that just 6% of home-buyers use. It’s safe to say that if you’re applying for a mortgage, it will MOST LIKELY be a 30 year loan.
How Does a Mortgage Work?
If you choose to use a mortgage to buy your first home, the lender (the bank or financial institution) will technically own the home outright. You will make regular mortgage payments (typically monthly) to the lender for the predetermined length of time (usually 30 years). These payments will include the principal amount and interest. It may also include other expenses like property taxes, private mortgage insurance and homeowner’s insurance.
Your mortgage’s interest rate is typically determined in one of two ways – fixed or adjustable.
Just as it sounds, a fixed-rate mortgage offers an interest rate that will not change over the lifetime of your mortgage. If you lock in a fixed interest rate of 3.5%, your interest rate will not change from that 3.5% for the entire length of the loan. From year one to year 30, you can expect to pay the same interest rate.
Adjustable-Rate Mortgages (ARMs)
In direct contrast to a fixed-rate mortgage, an ARM will include varying interest rates over the lifetime of the loan. With an ARM, the lender will offer a set interest rate for the first few years (typically the first 3-10 years). After that designated time period, the interest rate can actually increase from there. This would mean more that you’re paying each month.
While ARMs usually offer a lower initial interest rate than fixed-rate mortgages, the borrower is taking a chance on whether or not that rate will eventually rise. If you plan on selling this first-home sooner rather than later, you COULD take the chance on an ARM, though it’s generally not encouraged. Talking to a financial planner can really help you determine which type of mortgage is right for you. There is also the plan of refinancing your mortgage before the fixed period is up, but again that is a roll of the dice when it comes to predicting where interest rates might be.
How Is a Mortgage Payment Calculated?
Let’s assume you’re taking out a 30-year fixed-rate loan for a $200,000 house. Here’s what your mortgage payment will likely include:
- The principal amount: This is how much you bought the property for, minus your down payment. If you bought a $200,000 home and put down $20,000 (10 percent) upfront, your principal amount for the loan would be $180,000. For a 30-year loan, we’d divide that amount into 360 monthly payments – about $500 per month.
- The interest: Assuming you’re using a fixed-rate mortgage, your interest rate will not change over the life of the loan. Let’s say your annual interest rate is 4%. You’d need to divide that amount by 12 to find out how much you’ll be paying in interest every month.
- Private mortgage insurance (PMI): If you plan on making a down payment of less than 20% when buying a home, you will likely be required to pay a monthly PMI premium. In most cases, this insurance will no longer be required once you have paid up to the 20% equity in mortgage payments.
- Property taxes: Your lender will establish an escrow account. This account will have money in it to pay things like property taxes. Property taxes will then often be included in your monthly mortgage payments. The lender then pays the full amount of taxes to the government on your behalf with the money you’ve contributed each month to the escrow account.
- Homeowners insurance: Most mortgages require a homeowner’s insurance policy. Similar to property taxes, the insurance premiums for the policy can be paid out of your escrow account by the lender.
For first-time home buyers, there is a LOT of planning that needs to be done. Considering all of the different options when it comes to mortgages is something a financial planner will be able to help you with. It’s important to have this base-knowledge about mortgages before applying for one. If you have more questions about mortgages or the home-buying process, we would be happy to speak with you. Click this button here to schedule a meeting with our team.