According to Investopedia, a “mortgage is a type of loan used to purchase or maintain a home, land, or other types of real estate.” The borrower commits to paying their lender over time in a series of regular payments that are divided into principal (the original amount of money borrowed) and interest (“monetary charge for the privilege of borrowing money, typically expressed as an annual percentage rate (APR),” says Investopedia). The property or land becomes collateral to secure the loan.
A mortgage allows individuals and families to purchase property with only a small down payment (relative to the full price of the property), effectively borrowing the difference and promising to pay it back over time.
How Do I Get a Mortgage?
You must apply for a mortgage loan through your preferred lender, meeting all of their requirements. Though qualifications vary, Freddie Mac explains that lenders will establish the risk in lending to you by examining the four C’s:
- Capacity to pay back the loan: Your lender wants to ensure you can make your mortgage payments every month, so they’ll examine your income, employment history, savings, monthly debt payments, and other financial obligations. Your income will be verified by reviewing several years of your federal income tax returns, W2s, and current pay stubs with special consideration of the source and type of income, how long you’ve been receiving the income and if it’s stable, and how long that income is expected to continue. They’ll also consider your recurring monthly debt or liabilities, including your car payments, student loans, child support, etc.
- Capital: Since you’ll owe the lender money every month, they want to understand what readily available cash, savings, investments, and assets you have on hand, just in case you hit hard times. Having cash reserves indicates that you can manage your finances and can successfully pay your mortgage.
- Collateral: Lenders evaluate the value of the property that you’re pledging as security against the loan, the article states. If you don’t make your monthly mortgage payments, the lender could take possession of your home via foreclosure. To assess the fair market value of the property you’d like to purchase, your lender will order an appraisal of the property and compare it to similar homes nearby.
- Credit: To understand your record of paying bills and other debts in a timely manner, your lender will check your credit score and history. Most mortgages have a minimum credit score requirement, though your credit score can influence much more. The amount you’ll have to pay as a down payment and your final interest rate could be dictated by your credit score.
The Most Common Mortgage Types
There are a variety of loans available for borrowers, making it crucial for you to find a lender you trust. Explain your goals, and your lender should be able to find the mortgage product that best aligns with your plans. That said, it’s worth knowing your options!
Fixed-rate Mortgage
The most common types of mortgages are 15-year and 30-year fixed-rate mortgages, meaning that the interest rate and monthly payment amount stay the same for either 15 or 30 years. This type of loan is also called a traditional mortgage.
Within this category fall:
- Federal Housing Administration (FHA) loans
- U.S. Department of Agriculture (USDA) loans
- U.S. Department of Veterans Affairs (VA) loans
Adjustable-rate Mortgage
Another type of loan is the adjustable-rate mortgage (ARM) in which the interest rate is fixed for an initial period of time, after which it can change on a set schedule based on current interest rates. The initial interest rate is usually below market but rises substantially, meaning that the loan may be more affordable in the short term but more expensive in the long term (if rates rise).
Investopedia notes that ARMs typically have limits on how much the interest rate can rise each time it adjusts and in total over the life of the loan. When reviewing ARMs, they’re often represented by a fraction.
For example, you may see a 5/1 adjustable-rate mortgage. That means the ARM maintains a fixed interest rate for the first five years, then adjusts each year after that point.
If you’re interested in learning more, we’ve put together a free webinar to help you learn more about financing options to purchase propert