Home Buyer’s Guide Part 2

Explore Your Mortgage Options

The Three Aspects of a Mortgage
There are three basic parts of a mortgage: the loan type, the rate type, and the loan term. Understanding each of these pieces, and how they interrelate will help you make the best choice of mortgage.

Loan Type

The mortgage type is determined by the size of the loan, and if the loan involves private investors or a government agency.

Federal Housing Administration (FHA) loans are the easiest type to qualify for, and are generally intended for first time homebuyers. Their down payment and credit score requirements can make homeownership a reality for people with less than perfect credit or minimal savings. A downside to FHA loans is that they require mortgage insurance, adding to the monthly payments. FHA loans are insured by the Federal Housing administration, meaning lenders are protected from losses by a government agency in the event homeowners default on loans. FHA loans are serviced by private lenders, meaning you can get an FHA loan from any lender who is FHA approved.

Conventional loans are serviced by private lenders, without backing from any government agency. They generally have somewhat stricter credit and down payment requirements compared to FHA loans, but can potentially save money over the life of the loan. If you put at least 20% down on a conventional loan, you won’t be required to carry mortgage insurance, which can reduce monthly payments by hundreds of dollars. Some conventional loans intended for first time homebuyers have down payment requirements similar to, or possibly even less than FHA loans, but these will require mortgage insurance.

Veterans Administration (VA) loans are only available to veterans, active-duty service members, and eligible surviving spouses. For those that qualify, VA loans can be a great option. They generally have low credit score requirements, don’t require mortgage insurance, and often require no down payment.

Jumbo loans are mortgages larger than the conventional loan limit. They are similar to conventional loans, but are only necessary in cases where the loan is between $453,100 and $3 million.

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Rate Types
Mortgages are either fixed rate or adjustable rate. Choosing which is right for you is a matter of deciding which best fits your situation.

Fixed-rate mortgages stay at the same interest rate for the entire life of the loan. They are best for buyers who plan to stay in the home for a long time, and want to be able to rely on a monthly payment that will never change.

Adjustable-rate mortgages have a given period of time in which the rate stays the same, typically the first 5, 7, or 10 years of the loan. After that period, the rate will go up or down once a year based on market conditions. This rate type typically allows for a lower interest rate compared to a fixed-rate mortgage, and is ideal for buyers who intend to sell or refinance before the fixed rate period ends.

Term
Term is the full length of the loan. Adjustable-rate mortgages generally have a 30 year term. Usually fixed-rate mortgages have a 15 or 30 year term, but many lenders allow buyers to choose other terms. Both term types have advantages, so chose the type that works best for your situation. Longer terms keep monthly payments lower, meaning you can have more cash on hand to save or improve your home. Shorter terms mean the mortgage will be paid off sooner, plus you pay less interest over the life of the loan and build equity more quickly.

Parts of your monthly mortgage payment
Each monthly payment will be composed of three parts – principal, interest, insurance and taxes.

Principle is the portion of your monthly payment that goes to paying off the balance of the loan. The portion of your payment that goes to principal builds your equity in the home, as it increases the percentage of home you’ve paid for.
Interest is the fee paid to your lender, to cover the cost and risk of providing the loan.
Insurance and taxes go to paying property taxes to your local government and homeowners insurance premiums to your insurance company. This part of your monthly payment is only included in your payments to your lender if you have an escrow account. An escrow account is a special type of account that lenders use to hold money that’s used to pay property taxes and insurance premiums. If you don’t have an escrow account with your lender, you’ll need to pay property taxes and insurance premiums separately from your monthly mortgage payments.
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