Entering the world of mortgages as a first-time homebuyer can be both exciting and intimidating. There are so many different options and terms that you know nothing about! The good news is that you don’t have to figure it all out on your own. With the right amount of research partnered with a helpful lender like Vaster Capital, you can confidently secure a mortgage and get the keys to your dream home in no time.
What Is a Mortgage?
A mortgage is a type of loan provided for the specific purpose of buying a property. You can buy anything from a single-family home, a condo, a townhome, undeveloped land, or even an investment property with a mortgage loan. Mortgage loans are provided by lenders that range from traditional lenders like big banks to non-traditional lenders like online lenders.
It’s often necessary to apply for a mortgage loan through a lender due to high home prices that are constantly rising. Unless you have hundreds of thousands of dollars in the bank to spend on a home purchase, you’re going to need a mortgage to make the dream of homeownership a reality.
The lender provides you with the funding you need to purchase your home and you pay them back on a monthly basis -- with interest, of course. While the basic concept may seem simple at first, there’s a whole lot more to the process than meets the eye -- so stay tuned to learn more about mortgages and how you can obtain one.
What Are the Different Components of a Mortgage?
Now that you know the basics surrounding mortgage loans, it’s time to get into the nitty-gritty. There are many different components of a mortgage loan that you may or may not be aware of. So no matter if you’re a first-time homebuyer or an experienced homebuyer, let’s break these different components down to give you a good idea of what to expect throughout the process:
The amount that you automatically associate with a mortgage is referred to as the principal. This is the amount that you initially borrow in order to afford the home without any interest involved. Many people assume that the principal is the same thing as the sales price of the home when in reality, this is not the case. This is because in most cases, buyers are required to put a certain percentage of the home’s value “down” at the time of the sale.
For example, it’s generally recommended that you have a down payment of 20% of the home’s value. So if you’re purchasing a $300,000 house, you would put $60,000 and have a loan principal amount of $240,000 that you would make monthly payments on.
Lenders don’t provide you with a loan for free. Instead, they charge you interest in exchange for their services. Interest rates tend to vary depending on the risk you present to the lender. So if you have a solid employment history and excellent credit, you can secure a lower interest rate. For example, current interest rates on 30-year fixed mortgages average right around 3%. So if you pay 3% interest per year on your $240,000 mortgage loan, you will pay $7,200 in interest for that year.
While taxes aren’t levied by the lender, they are an important cost associated with homeownership that plays into the mortgage process. For instance, property taxes are paid based on your home’s value to pay for things in the community like schools, roads, parks, etc.
While property tax rates vary a lot depending on location, you should generally expect to pay $1 for every $1,000 of your home’s value in property taxes on a monthly basis. So for your $300,000 home, you’d expect to pay $300 a month in property taxes for a yearly total of $3,600.
The final component of your mortgage is insurance. Most lenders will require you to maintain a policy that covers your home throughout the life of your loan. Basic homeowners insurance policies cover things like fires, break-ins, and hail, and generally cost around $100 a month in premiums. In addition to basic homeowners insurance, some properties may be required to carry special insurance for things like flooding or earthquakes, depending on the prevalence of these events in the area.
Private Mortgage Insurance
Although not included in every mortgage, private mortgage insurance or PMI, is another added cost that you need to be aware of before buying a home. If you have a conventional loan with a down payment of less than 20%, your lender will likely require that you pay an additional amount for mortgage insurance each month until you reach 20% equity in your home.
Once you have reached enough equity, your lender will cancel your PMI and your monthly payments will decrease. The exact amount of PMI can vary, but you should expect to pay somewhere between 0.58% to 1.86% of the original loan amount on an annual basis.
If you have a federally-backed mortgage with a down payment of less than 20%, you are required to pay a similar mortgage insurance premium (MIP). The only difference here is that you will have to pay it throughout the entire term of the loan -- it doesn’t get dropped once you reach a certain amount of equity. The cost of MIP typically ranges between 0.45% and 1.05% of the loan amount on an annual basis.
Total Cost and PITI
All of these components together make up “PITI” which can be calculated to determine the total monthly cost associated with your mortgage. So let’s calculate the PITI for our running example:
Principal and Interest: For a 30-year fixed-rate loan of $240,000, your monthly payment would be $1,012
Taxes: $300 per month for a total of $3,600 per year
Insurance: $100 per month for a total of $1,200 per year
Total cost: Your total mortgage cost would be $1,412 per month
How Much Can You Afford to Pay for a Mortgage?
Based on this information, you’re able to figure out how much you’re able to pay for a mortgage every month. Experts generally recommend that you spend no more than 28% of your gross monthly income on housing-related costs. So in order to afford that $240,000 mortgage loan, you would have to make at least $44,764 a year before taxes.
Obviously, it’s always a good idea to limit what you spend on housing costs instead of maxing yourself out -- so just use this as a general guide rather than what you have to pay for a home.
Different Types of Mortgage Loans
If you’re already panicking about the thought of having to somehow come up with a 20% down payment -- you’re in luck! There are many different types of mortgage loans out there for you to consider that could make homebuying more realistic and accessible.
Here are some of the different types of mortgage loans that you should know about:
This type of mortgage offers a fixed interest rate that does not change throughout the life of the loan. Fixed-rate mortgages are the most common types of mortgages taken out. A fixed-rate mortgage guarantees that your interest rate will not rise during the loan term. The most common loan terms for fixed-rate mortgages are 15 years and 30 years.
This type of mortgage offers a fluctuating interest rate that changes depending on the market. The most common type of adjustable-rate mortgage is a “5/1” mortgage. This means that the loan begins with a fixed interest rate for a period of five years. After the initial five years, the interest rate adjusts once per year for the remaining term of the loan. Adjustable-rate mortgages are riskier as they are based on market forces that can rise and fall unpredictably. However, they could be beneficial on a short-term basis as a way to receive a lower interest rate initially and sell before the interest rate starts to fluctuate.
This type of mortgage allows the borrower to only make interest payments on the loan for a specific amount of time rather than having to pay both interest and principal at the same time. At the end of the loan term, the borrower is then required to make a “balloon payment” of a large lump sum to cover the rest of the balance due. Again, this option could work if you’re looking for a short-term purchase, that way you can enjoy the low monthly payments and sell before the balloon payment is due.
This type of mortgage is guaranteed by the federal government to decrease the risk taken on by lenders. Federally-backed mortgages fall into three different types: FHA mortgages backed by the Federal Housing Administration, VA mortgages backed by the Department of Veterans Affairs, and USDA mortgages backed by the Department of Agriculture.
FHA mortgages typically have less stringent requirements to make homeownership more accessible to those with lower incomes. For instance, those with credit scores above 580 can typically apply for FHA loans. FHA loans also allow borrowers to put down less money for a down payment -- potentially as low as 3.5%. However, FHA loans come with extra costs in the form of a mortgage insurance premium that can cost anywhere from 0.45% to 1.05% of your loan value on an annual basis.
Full Documentation Mortgage
This type of mortgage requires borrowers to prove a steady work history through documentation like tax returns, W-2s, 1099s, and pay stubs. Full documentation mortgages will also check your credit history, including any debts that you carry, in addition to liquidity through bank statements and account statements.
Low Documentation Mortgage
This type of mortgage requires less documentation and is ideal for individuals and businesses without a documented or substantial work history. Instead of requiring tax returns, W-2s, 1099s, or pay stubs, you can qualify for this mortgage through credit scores, assets, and cash accounts. Specifically, this type of mortgage is ideal for foreign investors that may not have the types of documents needed to qualify for a full documentation mortgage.
Do You Qualify for a Mortgage?
Now that you have a better idea about some of the different types of mortgage loans that you may qualify for, it’s time to talk about the details. Exactly what qualifications are lenders looking for when they review your loan?
Here are some of the things they may consider:
Your income documented through tax returns, W-2s, 1099s, and pay stubs.
Your debts, including student loans, automobile loans, and credit card debt.
Your income and your debts are used to calculate your debt to income ratio, or DTI. Generally speaking, lenders are looking for a DTI ratio below 36% -- including the proposed cost of your mortgage.
Your credit report including payment histories, defaults, evictions, etc. Most loans require a credit score above 620 in order to qualify, but if you’re looking to obtain favorable interest rates, then you should aim for a credit score that’s above 740.
Your bank statements to verify where your down payment is coming from. Lenders do not like to see large cash deposits with no discernable origin.
With all this documentation, you can officially apply for a mortgage either online or in person.
A Breakdown of the Mortgage Process
Once you know that you qualify for a mortgage, you can move on to actually securing a mortgage. However, the process isn’t exactly straightforward. Thankfully, we are here to guide you through each step in the process for a seamless homebuying experience.
Step 1: Application
The first step in the mortgage process is the application -- which you now know all about. Before you apply, it’s a good idea to gather all of the necessary documentation to make the process easier.
Generally speaking, lenders will want to see two year’s worth of income statements like W-2s or 1099s, 30 day’s worth of pay stubs, two to three year’s worth of income tax returns, two to three month’s worth of bank statements, retirement account statements, and investment account statements.
If you are using gift money for your down payment, then you will need to include a gift letter and potentially bank statements from the donor to show the origin of the money. Additionally, lenders may ask for information about child support or alimony if you’re using that as income. Finally, lenders may request proof that you have made any and all rent payments for the past 12 months as well as contact information from your landlords for a reference check.
Step 2: Approval
The second step in the mortgage process is the approval. Based on your application, the lender will pre-approve you to borrow a certain amount of money to purchase a home. Getting this information before you start looking for a house can help you determine your budget so that you don’t get your heart stuck on a house that you can’t actually afford.
However, just because you are pre-approved to borrow a certain amount doesn’t mean that you necessarily have to spend that much on a home. In fact, lenders may approve you for more than you should actually spend. If you take a more modest approach in terms of budget, you can have more money left in your pocket to spend on home maintenance, repairs, renovations, furniture, etc.
Step 3: Find a Home and Make an Offer
Once you have been pre-approved, you can actually start looking for your dream home. Having a pre-approval in hand shows realtors and sellers that you are serious about buying a home. Look for a realtor that knows your area well and has plenty of negotiation experience. The right realtor can help you make a competitive offer once you have found your ideal property.
Step 4: Offer Is Approved
After making an offer, hopefully, that offer is then approved without any additional negotiations. However, thanks to an extremely competitive market, you may need to go back to the seller with a better offer that will help you beat out the rest of the competition. Once you have submitted the right offer, the seller will accept it and you can move forward in the process.
Step 5: The Underwriting Process
The next step in the mortgage process is underwriting. This occurs once you’re under contract on a home to verify the information included in your initial mortgage application and finalize the details of your loan like amount and interest rate. The underwriting process also verifies information related to the property you’re purchasing.
Most lenders will require that the property be appraised. An appraisal is used to show that the lender isn’t giving you more than the property is actually worth. A professional appraisal will come to look at the property to evaluate its condition and features. From there, they will compare the property to similar ones in the immediate area within the past six months, known as “comps” to come up with its appraised value.
Since lenders will not give you more than the property is worth, you will be required to personally make up the difference if the house doesn’t appraise at the purchase price. This is something you need to be prepared for in terms of extra cash reserves.
Although not technically a part of the underwriting process, many buyers choose to order an inspection on the property for their own peace of mind before moving forward in the process. An inspector will come to visit the property to evaluate it for any issues that may be present with its structure, appliances, systems, etc. A thorough inspection helps the buyer be better informed about such a large and important purchase. If any issues do come up, the buyer can ask the seller to cover the costs of repairs, choose to cover the costs themself, or walk away if the contract included an inspection contingency.
Step 6: Closing Day
Finally, the last step in the mortgage is closing day! You sign all sorts of different documents on closing day that officially and legally transfer the property from the seller to the buyer. The funds are then transferred for the purchase and you receive the keys to your new home. It’s time to celebrate!
How to Find the Right Mortgage Lender
The right lender can make or break your home buying process. However, finding the right lender is easier said than done. You should look for a lender that is reputable, responsive, and trustworthy. To find the right lender, speak to friends and family to see if they have any recommendations. You could also conduct an online search to find online lenders to work with.
For example, Vaster Capital is a lender that offers custom mortgage solutions for residential and commercial real estate. We offer short-term mortgage solutions catered to your investment needs so that you can execute real estate transactions quickly and seamlessly.
Final Thoughts on Mortgages
The mortgage process begins and ends with your lender, so finding the right one is a key step. If you’re thinking about buying a home and applying for a mortgage but aren’t sure what to do next, feel free to reach out to the lending experts at Vaster Capital for professional feedback and advice. We are always ready and willing to help you secure your dream property.