A mortgage is a debt instrument, secured by the collateral of specified real estate property that the borrower is obligated to pay back with a predetermined set of payments. They are commonly used by individuals along with businesses to invest in large real estate purchases without paying the full value of the purchase right away. Over the years, the borrower will repay the loan, plus interest until they eventually own the property with no debt leftover.
Mortgages can come in different forms. First, lets focus on the Fixe-Rate Mortgage.
With this mortgage product, the borrower will pay the same interest rate for the full life of the loan. This means that the monthly principal along with the interest they must pay will not change over the course of the entire payment. Terms last commonly for 15-30 years. Homebuyers enjoy the fixed rate mortgage because they remain safe from uncertainties and fluctuation in the market.
If market interest rates dramatically increase, it won’t affect the fixed-rate borrower. But if market rates suddenly and dramatically drop, borrowers may have the chance to secure that lower rate by strategically refinancing their mortgage.
For most borrowers, the fixed-rate mortgage is the easiest and simplest mortgage to secure. The second most common type of mortgage is the Adjustable-Rate Mortgage.
The adjustable-rate mortgage, or ARM, differs from the fixed rate-mortgage in that the interest rates will fluctuate with market interest rates. The terms generally consist of a fixed interest rate for a pre-determined initial term, and then 1 or 2 rate “hikes” during the remainder of the loan.
For example, a “5/1” ARM means that the initial fixed-rate term is 5 years, with 1 rate increase over the remaining years of the loan. The lender makes the determination when the rate increase will happen.
ARMs are often advertised as offering a rate which often appears to be below the market rate, making it seem more affordable in the immediate term. But borrowers often overestimate the affordability of an ARM. When that interest rate increase occurs, it can hike your monthly mortgage payment up by $100, $200, or even $400 in interest only.
On the other hand, interest rates could drastically decrease, making the adjustable rate mortgage less expensive for that initial 5 years. This type of mortgage is risky in nature but has the potential to payoff if strategically executed.
Now that you know your options when it comes to mortgages, how do you decide which to pick? Buyers who want to take the home buying process seriously must meet with a lender to obtain a mortgage pre-approval.
Getting Pre-Approved for a Mortgage with a Lender
Getting pre-approved with a mortgage lender is a vital step in the home buying process because it will determine what terms you qualify for (and therefore a price range for a home). Sellers want to know that buyers are pre-approved so they are able to feel more confident in your offer, when you make it.
Many borrowers get tripped up in the difference between being being pre-qualified and pre-approved. The pre-qualification process for a mortgage consists of meeting with a lender to provide information about your personal assets, income, liabilities and other financial concerns. This helps give the lender some insight into the credibility of the borrower.
Although being pre-qualified is the first step in the right direction, it does not carry the same weight as a pre-approval does. The pre-qualification is generally just a “ballpark” amount you could expect to be approved for. For a pre-approval, the lender will run a credit check on you, which gives them a much clearer, objective picture of your financial health. Pre-approvals are much more accurate and thorough than pre-quals.
What Factors Affect my Mortgage Terms and Interest Rates?
There are different factors that affect the mortgage terms and interest rate a lender will offer you. Mortgage interest rates play a huge role on the long term cost of purchasing and financing of your home. Mortgage borrowers want to lock-in the lowest rates possible, while mortgage lenders need to account for the level of risk they are involved in through the interest rate they charge.
Therefore, the lender sets the terms and interest rate you can borrow at.
Generally speaking, the more solid your financial footing, the better your offered terms and rate will be. Factors in the economy also play a big role in mortgage interest rates. A common indicator of interest rates is the housing market itself – when homes are in high demand, and people want to borrow more principal, interest rates drop.
If you’re a first-time home buyer, we suggest working with a mortgage broker. There are several reasons why, among them being that financing a home is a complicated and burdensome process. It’s good to have someone on your side representing you to lenders.
We wrote an article on the benefits of working with a mortgage broker, so check that out. And when you’re ready to get started in your home search, we can offer you a list of qualified, experienced mortgage brokers that we trust.