Carol Lollich, Broker-Owner

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A Mortgage Primer

What is a mortgage?

A mortgage is a loan which is secured by real property. People use mortgages to help them purchase or refinance a home.

As with other loans, you must apply for a mortgage and get approved. The amount you can borrow depends on several things, such as your monthly income, your total debt and your monthly expenses.

Once your mortgage is closed, you receive the total amount of the loan at once, which is used to pay the seller (in a sale transaction) or pay off any existing loans on the property (in a refinance transaction). You then repay the loan in monthly payments according to a predetermined schedule. Most mortgages today are for periods of 15, 30, or 40 years.

Types of Mortgages

To determine the right type of mortgage for your needs, you should consider:

Today, there are a variety of mortgages to fit every home buyer's needs. The most common types are:
  • Fixed rate mortgages
  • Adjustable rate mortgages
  • Balloon mortgages
  • FHA mortgages
  • VA mortgages
  • Conventional mortgages

Fixed Rate Mortgages

The interest rate on a fixed rate mortgage remains constant over the life of the loan. With a fixed rate loan, your monthly principal and interest payment will always remain the same.

Fixed rate mortgages are especially suited for those who expect to remain in their homes for a number of years.

For fixed rate mortgages, you can provide a downpayment as low as 5% of the purchase price with many lenders. And, many have programs where the down payment can be from a combination of your own funds and "gift" money.  

Advantage of fixed rate mortgages:

Adjustable Rate Mortgages (ARMs)

An adjustable rate mortgage offers borrowers an interest rate that fluctuates over time. Generally, the initial interest rate is lower than that of a fixed rate mortgage. The initial rate is in effect for a specific period, usually six months to a year, and then the rate and payment adjust. There are always predetermined limits or "caps" to the amount the rate can fluctuate.

According to how prevailing interest rates change, lenders will adjust the ARM interest rate to a regular schedule, determined when you apply for the mortgage. The lender bases its calculations on the index1 and margin of the mortgage. The index1 is a base rate that is always a published number, like the interest rate for U.S. Treasury securities.  (Some other indices used are "11th District Cost of Funds, and Libor index1).  The margin is a fixed percentage rate that the lender adds to the index1 at each adjustment period to determine a new interest rate. Be sure to check the type of index1 your mortgage lender is using, because some fluctuate more than others.

Advantages of adjustable rate mortgages:

Balloon Mortgages

Payments remain constant for the term of a balloon mortgage which is usually 5-7 years, although principal and interest are amortized over 30 years. At the end of the 5-7 years, you can pay off the mortgage or apply to refinance.

Advantages of balloon mortgages:

FHA Mortgages

A Federal Housing Administration insured loan allows you to buy a home with a low down payment, ranging from 3% to 5% depending on the price of the home. This may provide you with more buying power.

VA Mortgages

If you are currently in the United States military, or if you have ever served in U.S. armed forces, you may be eligible to get a loan guaranteed by the Veterans Administration. If you qualify, this special government benefit to veterans might be a good option for you as it allows you to purchase a home with a low down payment.

Conventional Mortgages

Conventional mortgages are mortgages that are not obtained under a government insured or guaranteed program such as FHA or VA. Some of these loans may also be defined as conventional conforming loans which means they are eligible for purchase by one of the two government chartered corporations created to support the secondary mortgage market. These corporations are the Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac) and the Federal National Mortgage Association (FNMA or Fannie Mae).

Closing Costs (Also, see Buyer's Estimated Closing Costs)

There are several kind of fees associated with a mortgage. Many lenders charge an origination fee and a processing fee. Other fees associated with loan closing include, but are not limited to, your attorney's fees, filing fees, mortgage taxes, title search and title insurance. You may also be asked to pay real estate taxes and/or establish escrow accounts for real estate taxes and home owner's insurance.

Annual Percentage Rate (APR)

Annual percentage rate or APR is the actual cost you are paying for the mortgage loan. The APR reflects the cost of your mortgage loan as a yearly rate. It will generally be higher than the interest rate. All fees that are paid directly to your lender, the interest rate paid on the mortgage, and any mortgage insurance premiums are considered when calculating APR.