Mortgage Loan Basics Spelled Out: Lending 101

Let’s talk about mortgage loan basics.

Although they are often the largest debt an individual will experience in their lifetime, mortgages are a wonderful creation. Imagine if you had to pay cash up front for any home you wished to purchase. How many bedrooms would you have in that scenario? How many square feet? If it were me, I’d probably have to forego having a roof for the first year or two until I could save up for such luxuries.

Mortgages also keep interest rates moderated. Because the property acts as natural collateral for the loan, lenders are able to be somewhat flexible with their terms. It’s not that they want to take your home, but it does give them a safety net of sorts so that they can reasonably take the risk of loaning you funds to begin with.

Get Introduce Yourself With Mortage Loan Basics

A mortgage is a loan on the property – for example, your home – which is paid back over time to the lender along with an agreed upon interest rate. What makes it different than a simple “loan” is that the lender has the right to take over the property if payments are not made. This is sometimes called having a “lien on the property”. In other words, you don’t fully own the property until the last payment is made. That’s called “paying off your mortgage.”

Fixed-rate Mortgage

A fixed-rate mortgage is one in which your interest rate remains the same for the life of the loan. The monthly payments stay pretty much the same (there are other costs besides interest, but we’ll get to those) from your first payment to your last. These are the most typical type of mortgage and sometimes simply referred to as a “traditional mortgage”. The payments are generally structured so that your early payments go towards the interest on the loan. Over time, your payments apply more and more towards the principal of the loan – the actual money you borrowed to buy your house.

You’ll sometimes hear the term “amortization” used to describe this system. I wouldn’t get too sidetracked by it; it’s pretty much the universal way things are done when it comes to mortgages. The important thing is that the amount of your monthly payment devoted to principal plus interest stays the same, even if how much of each payment goes where evolves over the life of the loan.

Some lenders offer a “hybrid” of fixed and adjustable-rate mortgages. You’ll agree to a low, fixed interest rate for a specified length of time – say, the first five years of the loan. After that, the rate is adjustable based on market rates. The idea is that new homebuyers lock in a “grace period” of sorts at a lower rate than would be possible with a traditional fixed-rate mortgage. If you’re new to the adult world or just starting a family, the assumption is that a few years down the road you’ll be in a better position to tackle a higher house payment in exchange for that initial period of smaller payments.

Other Payment Factors

Either way it’s figured, interest plus principal is the bulk of your payment each month. Those are fundamental mortgage loan basics. But they’re not all of it. Remember those other factors in the cost of the loan we mentioned above? The two most common elements packaged with your mortgage payment are insurance and taxes.

Most lenders will expect you to purchase enough insurance to cover the cost of the home in case of fire, flood, meteor shower, etc. Remember – your home is collateral for the loan, and it’s not unreasonable for the lender to expect their interests to be protected. Depending on the details of your coverage, your monthly payment can go up (or down) over time based on changing insurance rates.

The other way lenders protect themselves is by making sure you’re able to pay any property taxes associated with your home. If you don’t pay your taxes, the government might take your home and then both you and the lender are out of luck. Lenders guard against this by estimating the annual property taxes and dividing that amount by 12 months, then simply adding it to your required mortgage payment.

But Here’s the Trick

The folks doing the estimating and the folks determining your actual property taxes each year aren’t the same folks. Besides, property taxes go up and down depending on any number of factors. That’s where your “escrow account” comes in. As you make your monthly payments, they take the amount set aside for taxes and put it into “escrow” to be paid to the government come tax time. If your escrow has too much, you’ll get a small refund. If there’s too little, you’ll get a bill asking you to add a bit. Depending on the details of your mortgage, this might increase (or decrease) your monthly payments as adjustments are made to cover those taxes.

If all of this seems a bit overwhelming, don’t panic. Many people live long, happy lives without all the big words and complex financial computations. Our goal for now is to have a better general understanding of mortgage loan basics. Honestly, just by having read this far, you already know more than most.

Whether that’s frightening or reassuring I will leave up to you.

Home Buying Step 1 – Find a Lender

I know, I know – house shopping is the fun part. Imagining what you’d do to this kitchen or how you’d utilize that den, just like on all those TV shows. But the right mortgage and mortgage provider is essential to a positive home-buying experience. Shop your options first, before you’re all giddy over the closet space. It’s easier to pay attention to things like interest rates and closing costs that way.

Home Buying Step 2 – Get Pre-approved

You get two mortgage shopping tips on this one. First, pre-approved financing is pretty much required when buying a house. Some realtors won’t even start showing you properties until you’ve got the money lined up. And a pre-approved mortgage makes it much easier to move quickly on a home you really want. Your mortgage provider will even give you an official letter showing how much you’ve been approved for just to keep things official. This isn’t unexpected – it’s mortgage loan basics.

Second, the “pre” in “pre-approved” here doesn’t mean the financial stuff is settled and over. It merely means you have a solid indication of how much you can spend and that your lender is reasonably certain you’ll qualify to borrow that amount from them if you choose to buy a house. That’s when the real paperwork begins.

Home Buying Step 3– Look at Homes

Finally, the fun part! Don’t be that person who finds something wrong with every house, but neither should you jump at every opportunity. Make a short list of must haves, wants, dislikes, and must avoid, and do that part well ahead of time before you’re caught up in the moment. Then, refer to it as you go. Even if you modify it along the way, it will help you keep focused and remember your priorities.

Home Buying Step 4– Make an Offer

This is where a good real estate agent is so important. They can help you figure out a reasonable starting offer based on activity in the market, the area, the home itself, etc. If homes are selling quickly, it may be pointless to make an offer below asking price. At the same time, there’s usually no harm done by a little cautious negotiating. It doesn’t have to be all about the asking price, either – sometimes sellers will agree to leave the washer and dryer or replace that weird section of carpet instead of lowering their asking price.

Home Buying Step 5 – Brace Yourself (Now the Real Paperwork Begins)

If your offer is accepted, the lender will require you to complete a mortgage loan application and to submit documentation related to your income and financial history – pay stubs, W-2s, bank statements, tax returns, etc. These will be evaluated by an underwriter, whose primary function is to study the documentation provided and verify that everything is in order. There are lender requirements to be met and government guidelines to be followed and the whole thing can make your head spin a bit if you let it.

If it makes you feel any better, the underwriter is also measuring the value of the property in question and making sure it meets all sorts of requirements and guidelines as well. They may order a value assessment or other inspections if there are questions. These are all mortgage loan basics; it doesn’t mean there’s a problem.

Once the underwriter approves everything, you are “clear to close.” Everything is sent to a title company chosen by the lender (because there haven’t been enough people involved in the process yet).

Home Buying Step 6 – The Closing

Let’s talk good news and bad news here.

The good news is that you’re almost through the paperwork/financing/questions/approval part of the home-buying process. This is the last stage of small print and legal details.

The bad news is that if this is your first closing, there’s simply no way to be prepared for the volume of papers you’re about to be asked to sign or initial. Your next lesson in mortgage loan basics? Warm up your writing hand.

While you should always pay attention to anything you’re signing, nothing presented at this stage requires major decision-making or new action on your part. The representative from the title company will explain as you go and let you know which parts you should care about. While this part is tedious, it’s not hard. Traditionally, you’ll get the keys to your new home at the end of this part. Congratulations!

Oh – one last critical detail. You will be expected to bring a certified check or something comparable with you to cover your down payment and closing costs. These often include an initial escrow deposit and various fees to pay all the different people involved in the process up to this point. Your realtor will be able to let you know exactly how much this needs to be and what’s covered, so it won’t be a surprise. They’re not the same in every situation, and sometimes the seller agrees to take on part of these expenses as part of the negotiations. All that has been settled by this point, however, and it’s time to hand over your first check and get those keys.

Home Buying Step 7– Move In

This isn’t technically part of the mortgage process, but it’s sometimes helpful to remember why you’re putting yourself through all of this. Why are you dragging yourself through mortgage loan basics? It’s all been for this moment. Try to enjoy it.

Types of Mortgages

These aren’t entirely distinct forms of mortgages so much as variations you may encounter as you begin the process. A given mortgage arrangement can involve several of these factors together, or prove so straightforward that most of this terminology never even comes up. Still, knowing some terms common in mortgage loan basics might help you ask better questions of potential lenders.

Where to Shop for a Mortgage?

We thought you’d never ask.

There’s no harm trying traditional sources – your local bank or credit union or other favorite financial institution. But in the 21st century, you have numerous online options as well. That’s where we come in. We’re not trying to sell you anything or tell you what to do about your mortgage. That’s not our business. What we’re good at is connecting you to quality lender options based on the information you share with us about your needs and background. The rest is between you and them.