Homebuying 101

Loan Types & Terms

Learn how to tell a Fixed Rate Mortgage from an Adjustable Rate Mortgage and get some tips on what type of mortgage may be best for you.

Questions & Answers

What goes into a mortgage loan payment?

Your monthly mortgage loan payment consists primarily of principal, which is the amount of money borrowed for your loan + interest, which is a rate you pay to your lender for borrowing money.

In addition to these two amounts, you’ll be charged for items such as property taxes (based on the value of your home), as well as homeowner’s insurance to protect your new home.

Lastly, if your down payment is less than 20%, private mortgage insurance (known as PMI) will likely be included in your payment. This protects the lender if you fail to pay—or default on—your mortgage loan payment.

How do I best estimate the total out of pocket costs for my mortgage loan (inclusive of closing costs, etc.)?

The out-of-pocket costs for a mortgage loan generally consist of closing costs and a down payment. Other fees, such as homeowners insurance, property taxes, and other closing costs are usually due upon closing.

When you first apply for a loan, you’re entitled to receive an estimate of those closing costs up front, which the lender provides with a Loan Estimate that details the terms of the loan. This estimate will give you a pretty good sense of your closing costs, which are paid to the lender and others who perform services—like titles and appraisals—to process and close your loan. Overall, for your closing costs, you should expect to pay about anywhere from 2-5% of your loan amount, which you’ll pay before your loan closes.

In addition to closing costs, you’ll also pay a down payment up front, which typically ranges from 3-20% of your loan amount.

Homeowner’s insurance and property taxes vary based on the value and location of your house, so it’s best to check with your lender or your county.

How are mortgage loan payments calculated?

Mortgage loan payments are the sum of the following values:

Monthly principal & interest + mortgage insurance + property taxes + homeowners insurance + other fees, if applicable (such as condominium fees or mortgage insurance) = your mortgage loan payment.

What should I consider when comparing different mortgage loan options?

When choosing a mortgage loan, it’s important to consider how long you plan to own your home, as well as how essential it is to have a steady monthly payment. For first-time homebuyers, fixed-rate and adjustable-rate mortgages (known as conventional mortgages) are most common.

Fixed-rate mortgages have a set interest rate with a consistent payment over the course of the loan. This makes them a predictable option. It’s also an option to consider if you plan to own your home for many years.

Adjustable-rate mortgages (ARM) have fixed interest rates and payments for a set period of time, such as 5 or 7 years. After that period, the loan adjusts—typically once a year—based on the current market. Therefore, though the initial fixed rate is often low, rates could increase and cause higher monthly payments. While this option is less predictable, it’s something to consider if you plan to sell your home before the introductory period ends (e.g. within 5 years), or if you think interest rates may decrease.

Are property taxes included in my mortgage payment?

Property taxes—commonly called real estate taxes—may or may not be included in your monthly mortgage payment, so it’s important to check with your lender. Occasionally, you may also need to pay a portion of the property tax when you close your loan. And, since the taxes depend on the value and location of your new home, they will vary for each borrower.

What is mortgage insurance?

Mortgage insurance, also commonly referred to as private mortgage insurance, or PMI, is an insurance policy that reimburses the lender if a borrower defaults on their home loan. In most cases, if your down payment on a home is less than 20% of the home's price, you will have to pay for mortgage insurance as a monthly fee.

Mortgage insurance fees vary depending on the size of your down payment and credit score. On average, the fees will range between 0.3 percent and 1.5 percent of the original loan amount per year.

Is mortgage insurance included in my mortgage payment?

While mortgage insurance is occasionally included in closing costs, it’s most often included in monthly mortgage payments.

What is the principal payment?

The principal payment is the amount of your monthly mortgage payment that is applied to the principal, or the total money borrowed for your loan.

What is the interest payment?

When you apply for a loan—let’s say the principal is $200,000—you’ll be given an interest rate—e.g. 4%—which does not include fees charged for the loan. A portion of your monthly mortgage payment will go toward paying that interest.

What is loan amortization?

With an amortized loan, your regular monthly payments gradually reduce the principal amount owed over the life of your mortgage.

At first, the majority of your monthly payment is applied to interest, and the rest to principal. As you continue your payments, the amount put toward interest will gradually decrease, while the principal payment will increase, until your loan is completely paid off. To keep track of your payments, you’ll receive an amortization schedule with the amount of each month's interest and principal payments.

What is negative amoritization?

With an amortized loan, your regular monthly payments gradually reduce the principal amount owed over the life of your mortgage.

Negative amortization occurs when you make a minimum monthly payment, and none of that amount is applied to the interest. This essentially means you’re paying interest on interest, and the amount you owe increases over time.

What is a bi-weekly payment?

With bi-weekly payments, you have a mortgage payment due every two weeks. While not all mortgage companies offer a bi-weekly payment option, it’s something to consider if your budget will fare better with smaller—but more frequent—payments, especially if bi-weekly paychecks feed into your monthly mortgage payment. On the other hand, lenders may charge a fee for a bi-weekly payment plan.

What are the advantages of paying bi-weekly vs. monthly?

Bi-weekly payments coincide with a bi-weekly paycheck schedule, which is great for matching your mortgage payment with your paycheck. But there’s another advantage to the bi-weekly payment plan: the number of payments you make per year. There are 52 weeks in a year, for a total of 26 bi-weekly payments. In that case, the bi-weekly schedule allows you to make 2 more half-payments (1 whole monthly payment) per year than on a traditional monthly payment plan, which could help you pay off your loan faster.

What influences my loan interest rate?

The interest rate is directly influenced by the current market and is based on both the index (a benchmark interest rate based on the general market) and the margin (which varies by lender.)

How important is finding the lowest interest rate?

While finding a low interest rate is an important factor in choosing a mortgage loan, you should always consider the loan type as well as other costs associated with it, such as insurance, taxes, and lender’s fees.

Mortgage loans with shorter terms often have lower interest rates, but that also means higher monthly payments. Therefore, picking the lowest interest rate could ultimately make budgeting more difficult, so it’s best to estimate the entire cost when selecting a loan.

What are the best loan programs for low interest rates?

A fixed-rate mortgage is your best option for a predictable interest rate, as the rate remains stable over the life of the loan. Adjustable-rate mortgages may offer lower rates at first, but your interest rate could increase after the initial fixed period.

What is APR?

APR stands for annual percentage rate, or the annual cost of a loan. APR includes other charges and fees, such as closing costs and mortgage insurance, to reflect the annual cost of the loan.

Like the Loan Estimate, lenders are required to provide you with the APR under the Federal Truth in Lending Act. LendingHome recommends you always compare the listed APR percentage when comparing lenders since that figure provides a more holistic view of your options than an interest rate alone.

What is the difference between interest rate and APR?

Interest rate and APR are both represented by percentages, but the interest rate represents simply the annual cost of borrowing money, whereas APR includes the annual interest rate along with other charges and fees.

In general, APR—rather than the interest rate—gives you a better idea of the amount you’ll actually pay for a loan, which makes it a good basis for comparing offers from different lenders.

How can I lower my estimated interest rate?

Improve your credit score

– Higher credit scores often mean lower interest rates for borrowers.

– You can’t change your credit score overnight, but taking a look before you apply for a loan will give you a better idea of where you stand.

– This information will also help you pick the type of loan that’s best for you.

Increase your down payment

– The higher your down payment—leaving less money to pay back over the term of your loan—the lower your interest rate will likely be.

Buy additional points from your lender

– You have the option to buy points at closing to lower your interest rate.

– Each discount point you purchase = 1% of your loan amount, and reduces your interest rate.

– If you have a $200,000 mortgage and a 4% interest rate, one point would cost you $2,000 and would lower your interest rate (and payments) over the life of the loan.

– The longer you decide to stay in your home, the more you’ll benefit from buying points because your payments throughout your loan will be reduced.

What is an alternative documentation program?

Alternative documentation programs vary from lender to lender but were created in order to provide people with non-traditional work history (i.e. being self-employed) the opportunity to obtain a home loan. Qualifications for alternative documentation programs vary from lender to lender. In most cases, you will need a source of income, and the lender will assess assets, credit, and other information to make a decision.

What types of documents are required for an alternative documentation loan program?

Typically, the documents required for an alternative documentation program include pay stubs, W-2 forms, and bank statements.

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