Mortgage Explained Easily – House Financing, How-to, Guide
What is a mortgage? Which type of mortgage should you pick? In the complicated world of finances, we have written an easy guide, with mortgage explained so that everyone can easily understand what it is. We include the list of most popular mortgage lenders ranked, as well as the definition of downpayment, conventional loans, escrow account, etc. Everything you need to know about mortgages you will find below. More to find in our run-down on Additional Costs when Buying a Home.
What is a Mortgage?
Mortgage is a key component of any property investment. No matter the wealth or region, you’re gonna have to confront the facts about mortgage, the amount you’ll have to pay in total, and the interest. To pick the right mortgage you will need to be informed about everything there is to know about mortgages. All this and more below. If you want to save money on your mortgage, and you already know about saving money on real estate taxes, you should understsand it in detail. We begin with the definition of mortgage.
Mortgage Definition & Explanation
A mortgage is a type of loan. That means it is a sum of money which a lender pays on behalf of a borrower. A mortgage is a loan which is used to pay off property. The borrower is required to pay the money which they borrowed back, but not as a lump sum, but rather in rates. This means that e.g. as opposed to paying 1 mil. in one transaction, the borrower can pay 10.000 every month for 100 months. On top of this though, the lender typically requires interest, which is a percentage of the total loan which the borrower must pay on top of the rates.
What are All the Things you Pay in a Mortgage?
In a mortgage you pay more than just the amount which you borrowed. You pay additional fees at the point of closing the mortgage, you may have to pay a private mortgage insurance, and you will have to pay mortgage interest. The amounts you pay on these usually follow a formula where the more you pay at the closing of the sale, i.e. the more you pay up front on your mortgage, the less you pay later on or annually.
These are just some of the additional costs you pay when closing the purchase of property. This and many more closing costs for house purchases are detailed in our article on
The Loan
Of course, you are required to pay back the amount which you borrowed. If you borrow $500.000, you will need to pay this back in full at the conclusion of your mortgage. This is the simplest and most overseeable part of your mortgage, as well as the most substantial sum.
Mortgage Closing Costs
These are costs which must be paid up front when closing the mortgage. They pay for things like title insurance, application fees, etc. Mortgage closing costs are of course paid by the buyer of a property at the point at which the property is purchased. There’s too many to list, and these vary and depend on many things, but below some of the common ones.
- Loan origination fee: up to 1% of total loan
- Escrow fees: $350 – $1,000 but can be much more
- Appraisal: $500-$1,000 but can be much more
- Prepaid taxes and insurance: $1,000-$4,500 but can be much more
These typically range around 2%-5% of the total loan amount. So for a $750.000 loan you can pay an additional $37.500 in mortgage closing fees. They should not be confused with purchase closing costs, such as the taxes you pay when buying a house.
Discount Points
Discount points are points which you pay at the beginning of your loan. The more you pay here, the more discount you receive on your mortgage. If you ‘buy’ 2 discount points, you receive a discount of 2% on your mortgage.
Mortgage Interest
Interest is a price which you pay for the service and risk of someone loaning you money. Mortgage interest rates are expressed as annual payments, and are e.g. 5%. That means that every year you will pay an additional 5% of the total loan amount to the mortgage lender.
Our article covers everything you need to know about the topic
Who is the Lender?
Mortgages are most often loaned by independent mortgage companies. That means organisations who are specialized in lending mortgages. Although financial institution such as a bank or credit unions. In the USA, banks make up 32.4% of mortgages, credit unions make up 8.8%, with mortgage companies making up 54.4% of the market. These are not all the types of lenders though. Below is a list of all types of lenders in the USA.
What’s Better, Mortgage Companies or Banks?
It’s not difficult to save on real estate taxes generally, but you don’t want to spend more than necessary on your mortgage. Typically mortgage companies (or mortgage lenders) are more flexible. That means they can customize your loan, close your loan faster, and more open to negotiation. They also, because they are specialized in loans, typically have more expertise.
- Mortgage companies (e.g. Quicken Loans)
- Banks (e.g. Wells Fargo)
- Savings associations/loan associations (e.g. Mortgage Bankers Association)
- Online lenders (e.g. GuaranteedRate)
- Credit unions (e.g. Connexus)
- Private individuals (e.g. Family Friend)
What are the Most Popular Lenders?
The top lenders in the USA are Quicken Loans, United Wholesale Mortgage, and Wells Fargo. You can see quickly that specialized mortgage lending companies are the most popular choice at the moment. Here a list of the most used lenders in the USA for mortgages.
- Quicken Loans – 541,000 loans
- United Wholesale Mortgage – 339,000 loans
- Wells Fargo – 232,000 loans
- JPMorgan Chase – 186,000 loans
- Fairway Independent Mortgage – 147,000 loans
- loanDepot – 146,000 loans
- Caliber Home Loans – 136,000 loans
- Bank of America – 134,000 loans
- Freedom Mortgage – 110,000 loans
- U.S. Bank – 94,000 loans
Should You use a Mortgage Broker?
What are the advantages of mortgage broker versus a direct lender? A direct lender is an entity (e.g. a bank or credit union) which provides you funds, and to which you in turn pay interest. A mortgage broker is a middle man who is an expert in finding the best mortgage loan. In other words, a mortgage broker takes care of contacting and researching a direct lender.
- Direct Lender: Banks, Credit Unions, etc.
- Mortgage Broker: Middle man who finds the best deal
Mortgage brokers are advantageous if you have difficulties finding a loan. This can be down to low credit scores, or an income which makes lending to you unattractive. Mortgage brokers also often have access to mortgage lending programs unavailable to the typical citizen. Though you will have to pay an extra fee of course to pay the broker for their services.
- Brokers good for low credit scores or low income
Direct lenders such as banks are advantageous because you cut out a middle man. In this case you only have to pay a commission fee to the loan officer (the individual overseeing your loan at the institution). This also has the advantage that the broker is not acting in his own interest, e.g. choosing the institution which pays the highest broker fees.
- Direct Lenders allow to avoid broker fees
What are the Different Types of Mortgages?
There are a few different types of mortgage loans. These differ on three important variables. In other words when shopping for a mortgage loan, you must decide beforehand in which category you fall for each of the following three variables.
Conforming vs. Non-Conforming Loans
The U.S. government has set certain guidelines delineating ‘conforming’ and ‘non-conforming’ loans. These loans differ in the amount which you can borrow. This limit (as of 2020) is $510.000. That means when you receive a loan for more than this amount, you are receiving a non-conforming loan. Non-conforming loans have worse interest rates and fees than conforming loans. Within non-conforming loans the most popular is the ‘jumbo loan’.
Fixed Rate vs. Adjustable Rate
Fixed-rate loans and adjustable rate loans (also called adjustable rate mortgages) differ in the variability of interest rate, as the name states. That means fixed-rate loans incur the same interest over the whole period of the loan, while adjustable rate loans incur a rate which is set to change across the lifespan of the loan.
The first, fixed rate loans are attractive because there is safety. The interest rate will not change, and therefore budgeting and planning is easy. Typically fixed rate loans are more expensive at the outset than adjustable rates. Additionally, fixed rate loans are designated by time period. The most popular time frame is a 15-year fixed rate loan. That means the borrower pays back the loan and the same interest rate over 15 years.
Second, adjustable rate loans, are attractive to start with, because the rates are lower. Yet, because they can change, borrowers can be surprised that the interest rate increases over time. These also usually begin with e.g. 5 years of a fixed rate, after which the rate begins to vary.
- Fixed-rate = Same rate for full term
- Adjustable Rate (ARM) = Variable rate
Conventional vs. Government Backed
Government backed loans are loans which are insured or guaranteed by the government. Examples are Federal Housing Association (FHA) loans or Veterans Administration (VA) loans. If you have a non-conforming loan it is impossible to receive government backed loans. The main differences between conventional loans and government loans are that conventional loans have stricter requirements (e.g. better credit score and higher income), are insured privately, and the guidelines are more relaxed, meaning less paperwork.
Mortgage Terminology Explained
There are many words unique to the real estate loan market which are not used in every day life, making the understanding of mortgages more complicated for the layman. These words are explained below, with definition and explanation
Escrow
An escrow or escrow account is a savings account where funds are placed. This account is managed by your servicer, who deposits a portion of each mortgage payment into your escrow account to cover your estimated property taxes and insurance premiums. Not all mortgages come with escrows.
Mortgage Principal
Mortgage principal, also called loan principal is the amount outstanding on your loan. In other words, the amount left to be paid from the amount you borrowed. E.g. if you borrowed $400.000, and have paid $320.000, your loan principal is $80.000.
Down Payment
A down payment is a sort of deposit. It is the money you pay in advance to buy a house. You almost always have to pay a down payment to receive a mortgage. A larger down payment generally means better credit terms and a cheaper monthly payment.
Take for example a 5% down payment on your $1 mil. house. You only pay $50.000 at the point of purchase, but will pay a monthly private mortgage insurance, and likely higher interest rates. You can also receive discount points when paying more on your down payment, which reduces the interest rate. If you pay a 25% down payment, you’ll pay $250.000 at the point of purchase, but you will not have to pay private mortgage insurance, as well as receive a better interest rate.
- Larger down payment = lower interest
Mortgage Term
This is the period of time in which you pay off your loan. E.g. the fixed rate 15 year loan, has a mortgage term of 15 years. The longer the mortgage term, the higher the interest rates, and the longer the loan will be following you. Yet you will have to pay less each month.
Want to learn more about the many additional, and often hidden costs of buying a home? Our article covers everything you need to know
