What is a mortgage
Since you probably don't have hundreds of thousands of dollars lying around, a mortgage is a loan that enables you to cover the cost of a home. You pay back the loan over the course of years or even decades. Consider it the biggest, longest, most life-changing IOU you'll ever give out!
But there's a surprising variety of choices available. Here’s an introduction to everything you need to know about mortgages.
When to apply for a mortgage
Believe it or not, you should shop around for a mortgage even before you start hunting for a house. It might not be as fun as checking out open houses, but it’s way more important.
You’re looking to get a mortgage “pre-approval,” which serves two main purposes: One, it will show the sellers that you are serious about buying a home, which is particularly crucial in a hot housing market, says Chantay Bridges with TruLine Realty in Los Angeles.
But more importantly, it will let you know how much home you can afford. Before you start browsing online listings or visiting open houses, take a look at our home affordability calculator, which will give you an idea of how big your mortgage will be.
Where to get a mortgage
Here are the main places you can get a mortgage:
Banks: This can be a great place to start if you have an institution you work with that already knows you and your finances. That said, banks typically have only a few loan options so it’s smart to talk with your banker, and then compare the programs with a couple more options before settling on one.
Nonbank lenders: These companies (e.g., Quicken Loans or PennyMac Financial) are often willing to work with borrowers that banks avoid due to their riskier profile. If you have a poor credit history or some other blemish in your financial past, you may have better luck landing a loan with nonbank lenders, which now provide more than half of all loans.
Mortgage brokers: These advisers are specialists who can help walk you through a much wider variety of options to find a loan that’s right for you. They often work with many different lenders so they can help identify different rates and programs based on your specific situation.
Mortgage payments explained
When you apply for a mortgage, here are the main terms you'll need to know:
Down payment: This is the money you must put down on a house to show a lender you have some skin in the game. Typically lenders like to see home buyers make a down payment totaling 20% of the price of the home (e.g., $40,000 on a $200,000 home), although in some cases they'll take less.
Principal: This is the amount of money that you are borrowing and must pay back, which is the price of the home minus your down payment (taking the above example, you'd subtract $40,000 from $200,000 to get a principal of $160,000).
Interest: Lenders don't just loan you the money because they’re good guys. They stand to make money off you, too, since you pay them back plus interest—a percentage of the money you borrow.
Types of mortgages
Once you've got the answer to "what is a mortgage" answered, it's smooth sailing, right? Well, not exactly. Now you have to find out which type of mortgage is right for you. There are two main types of loans:
Fixed-rate mortgage: This is just what it sounds like. The interest rate will not vary over the life of the loan. While rates might be slightly higher overall, they are a good choice for someone who likes the certainty of knowing their payment will never go up.
Adjustable-rate mortgage, or ARM: These mortgages start with a lower interest rate for the first few years, and then they will “adjust” after a predetermined period (typically five years) based on market indexes. Borrowers enjoy the initial lower payments, but this type of loan can feel risky if interest rates rise a lot. However, there is a cap that can prevent too much damage.
Loans also have different “terms,” which means how long you’ll make monthly payments. The two most common terms are 30 years and 15 years. The payment on a 15-year loan will obviously be higher each month you have it, but it will ultimately save you money in interest over the life of the loan.
How to shop for a mortgage
Since loans come in all shapes, sizes, and interest rates, you should definitely shop around, much like you'd compare different laptops before settling on the best one for you. And, since interest rates fluctuate daily—which will have a direct impact on what you ultimately pay—you’ll want to do all your research during the same time period as much as possible, says Brandon Haefele, president and CEO of Sacramento-based Catalyst Mortgage and a member of the board of directors of the California Mortgage Bankers Association. That way, you know you're making a valid comparison.
Working with a qualified (and patient) loan adviser can help you sort out your options. They can help you determine which type of loan is best for your situation and walk you through what your payments would be for different types and terms of loans. They’ll also break down the various fees that come with each loan.
By understanding what a mortgage is and all the different types available, you can make the choice that’s right for you and your budget.