Get to Grips with Mortgage Basics:
Before you begin your mortgage journey, it is vital to understand the process and terminology involved. Having a good understanding of basic mortgage terms and concepts can make the process easier to navigate.
Let’s talk about some mortgage basics first, starting with defining what a mortgage is.
A mortgage in its simplest terms is a loan with interest normally provided by a bank to a person with the intention of purchasing real estate. Mortgages are also referred to as “mortgage loans.” They enable parties to purchase property without having the full purchase price upfront. It differs from other loans in that it is specifically used to finance the property.
So, who normally gets a mortgage and why?
The majority of people will require a mortgage to be able to purchase a home. A mortgage will be required if you cannot pay the entire cost of the property upfront. A mortgage is a necessity if you can’t pay the full cost of a home out of pocket. To qualify for the loan, you must meet certain eligibility requirements. Therefore, a person who gets a mortgage will most likely be someone with a stable and reliable income, a debt-to-income ratio of less than 50%, and a decent credit score (at least 580 for FHA loans or 620 for conventional loans).
There are some cases where it makes sense to have a mortgage on your home even though you have the money to pay it off. For example, investors sometimes mortgage properties to free up funds for other investments.
Who is involved in the Mortgage Process?
There are two parties involved in the mortgage process– a lender (normally a bank or financial institution) and a borrower (the person or persons seeking to purchase a property).
How Does A Mortgage Loan Work?
In the mortgage process, your lender provides the funds to purchase the home. You, as the borrower, agree to pay back your loan, along with interest for the entire term of the mortgage. The property will not be considered yours until the entire loan, along with interest, is repaid.
To help you on your journey, we have compiled a list of the most common words and terms you will encounter during the mortgage process.
Credit or FICO score: This is a 3-digit number based on your credit report that signifies to a lender your financial reliability. Your score can be lowered by bankruptcy, repossession, or a poor history of previous loan repayments. Your score can be raised by demonstrating consistency in loan repayments, ensuring bills are paid in full and on time, and maintaining a low balance on credit cards.
Foreclosure: The lender and borrower will normally have a mortgage contract which states that the lender can take ownership of the property should the borrower be unable to repay the full loan amount agreed including interest.
Appraisal: The valuation of a property’s worth to ensure that mortgage applicants do not borrow more than what they need for the purchase. This process is usually carried out by a third-party professional appraiser in exchange for a fee covered by the borrower.
Down Payment: These are the funds provided upfront by the borrower to purchase the property. These payments are typically 20% of the purchase price of the property but there are several government programs that can allow borrowers to pay less upfront. Generally speaking the larger the down payment amount you can make, the smaller your monthly repayments and interest rates.
Title: This is a document stating the legal owner of the property and depicting other property specifics.
Escrow Account: An account set up (normally by the lender) for making property-related payments such as taxes and insurance. Your lender will take a portion of your monthly mortgage payments and the funds will be held in this account and used to pay tax and insurance payments.
Interest Rates: The fee you are charged by a lender each month for taking out the mortgage. This is normally a percentage of the overall loan and can be fixed or variable. Fixed interest rates will remain the same throughout the term agreed between the borrower and the lender. They are predictable and can offer peace of mind but they lack flexibility and you will not save money if interest rates fall. Variable mortgages typically have better initial rates than fixed mortgages, but the interest rates adjust after a set period of time. The rates are locked for a term of usually 5-10 years then adjust up or down depending on the market rate. These rates can be difficult to predict so you can lose out financially if rates rise.
Mortgage term: The amount of time you will be making repayments on the mortgage, the most common being 15 and 30-year terms. Longer terms normally mean lower monthly repayments. However, shorter-term loans will normally have lower interest rates.
Promissory / Mortgage Note: These are the legally binding written guidelines and agreed-on terms for mortgage repayments. These normally include interest type, interest rate, mortgage term, and amount to be repaid.
Closing Cost: These are fees you will be charged after you secure a loan. Legal costs, Lender fees, escrow fees, home inspections and insurance are all things you can expect to pay when purchasing a home. It is recommended to generally expect anything between 3 – 6% of your home value. Your lender will provide a closing disclosure which informs you of these fees.
Home inspection / home inspector report: Before closing on a sale, potential buyers are strongly encouraged to hire a third-party professional to evaluate the overall condition of the home. They will generally inspect the home and provide a detailed report on its quality and safety. These reports make prospective buyers aware of costly or dangerous potential problems with the house in advance.
Remember, knowledge is power. Seeking unbiased third-party advice from experts in the legal and financial fields will help to ensure that your home purchasing experience is a positive one.