Unless you have a huge pile of cash, a big part of buying home is getting a mortgage.
There are many, many different types of mortgage loans. The most common type is a Fixed Rate Conventional Mortgage. I really like working with first time home buyers because I really like to explain this stuff. 🙂 So here we go:
Conventional Mortgage: A loan that is not insured or guaranteed by a government body. It conforms with Fannie Mae and Freddie Mac guidelines so these loans are generally sold off by banks to Fannie and Freddie. This doesn’t really affect the mortgage holder. Conventional mortgages require a minimum down payment of 5%. Conventional mortgages are generally Fixed-Rate, meaning that the interest rate does not change throughout the life of the loan. If it starts at 4% with a term of 30 years, it will still be 4% 30 years later, no matter what happens in the market.
Conventional mortgages are generally 15 or 30 year but different terms are available. Generally, the shorter the term, the better the interest rate.
You can you use a conventional loan to buy a primary residence, second home or investment property up to 4 units.
Down Payment: the amount of cash you bring to closing not including the closing costs (minimum of 5% for conventional mortgage loans).
Loan-to-Value (LTV): The mortgage amount divided by the appraised value of the house. For conventional loans, your LTV must be 95% or less.
For example, if you buy a house for $100,000, you would be required to put 5% down payment.
5% of $100,000 = $5,000 down payment
So the mortgage amount would be $95,000 and the sale price is $100,000 95,000/100,000 = .95 or 95% loan-to-value
Note: when you buy a home, the lender will do an appraisal to make sure that the home is worth at least as much as the mortgage amount. Even if your home appraises higher than the sale price, you still need to put down at least 5% of the sale price. The bank requires this so that you have some vested interest in the home and you won’t just walk away from the mortgage.
Mortgage Payment Parts (PITI):
Principal: The portion of your payment that goes toward paying down your loan.
Interest: Payment to the bank for lending you money. Does not reduce loan amount.
Taxes: Money that will go into escrow (see below) to pay real estate taxes.
Escrow is a holding account into which you will pay, as part of your mortgage payment, that the lender will use for tax payments. Most mortgages escrow for taxes and insurance so you don’t have to make those payments yourself. You will pay into the escrow account with every mortgage payment. Tax and insurance payments will be paid from this by the lender.
Insurance: Money that you will pay with each mortgage payment that will be used to pay your home owner’s insurance policy premium. (goes into escrow account each month)
You might also pay PMI (explained below) as part of your mortgage payment.
Private Mortgage Insurance (PMI): If you put less than 20% as a down payment, you are required to pay PMI. This is protection for the lender in case the loan holder defaults. The amount of PMI depends upon how much you put down. You’ll pay the highest PMI premium if you put the least down (5%). Once you pay down your loan to 80% loan-to-value (LTV), you can request that the bank eliminate your PMI. PMI is including in your mortgage payment.
Another note about PMI: If you buy a house and put less than 20% down, but then you do some renovations or upgrades and feel that your house is worth more, you can ask the bank to do another appraisal with the goal of getting rid of PMI. You will have to pay for the appraisal out of pocket and it’s usually about $400-500. If the appraisal value gives you an LTV less than 80%, it will eliminate the PMI.
An alternative to conventional mortgages are FHA Mortgages. I’ll talk about that in the next post. 🙂