What are Mortgages & How do they Work?
A mortgage is an agreement between a borrower and a lender that allows the borrower to purchase or refinance a property.
A mortgage loan is a type of “secured” loan created specifically to help people finance the purchase of real estate property, including houses, townhouses, condominiums, co-ops, lots and acreage, modular homes, commercial property, and others.
Secured loans require the borrower to designate an item or amount of money as security or collateral (in this case the borrower’s home) to secure the loan.
Because your home is used as collateral, if you default on the loan, the lender can take possession of your home. Repayment of a mortgage occurs over a fixed number of years (usually 15-30), at an interest rate specified by the lender at the time the loan is made.
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Read on to learn more about mortgage basics!
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How do Mortgage Payments Work?
Whether you get a mortgage on a home purchase or refinance, you will have monthly mortgage payments. The amount of the payment is based on the principal loan amount and the interest rate, as well as other amounts that may be included, such as property tax and homeowner’s insurance.
You will have the option to send payment by postal mail or have the amount automatically deducted from one of your accounts each month.
If you miss a payment or make a late payment, it will be reported by the lender to the credit reporting agencies, and your credit score will drop. Failure to repay a mortgage can result in the lender placing a “lien” on your property, and in the worst case, the lender can take possession of the property through the foreclosure process.
Use this handy
Mortgage Calculator to estimate your monthly payments, so you can determine how much you can spend on a new home.
Types of Mortgages
There are numerous types of mortgages. The following is a list of the most common mortgages offered by credit unions, banks and online lenders.
Conventional Loan. A conventional loan is one that is not a government-backed loan. There are two types of conventional loans, conforming and non-conforming.
Jumbo Loan. These loans are for high mortgage amounts (often used to purchase luxury homes). A jumbo loan is a non-conforming loan, as it doesn’t conform to the requirements of Fannie Mae, Freddie Mac, and their regulator, the Federal Housing Finance Agency (FHFA).
Government-Issued Loans. These loans are insured by the federal government. Examples include FHA, VA (Veterans Administration), and USDA.
Fixed-Rate Mortgage. All fixed rate mortgages have a fixed interest rate for the life of the loan.
Adjustable-Rate Mortgage (ARM). ARMs typically start with a promotional adjustable rate, then re-adjust periodically. This means your monthly mortgage payments will fluctuate higher or lower based on the financial index that the ARM is tied to.
What Kind of Mortgage is Right for Me?
Deciding which mortgage type is right for you can be based on your income and how much you can afford in monthly mortgage payments, the type of property, the price of the home, and the financial institution’s lending criteria that will identify which mortgage options work best for your unique situation. Here are some tips for deciding
how much house you can afford.
Important Terms to Know
Before applying for a mortgage it’s helpful to become familiar with these important terms that lenders and real estate agents will use when discussing your homebuying and borrowing needs.
Lender. A
mortgage lender is the financial institution that provides real estate purchase financing. Examples of lenders include credit unions, banks and mortgage companies.
Borrower. This is the individual or individuals who are getting the mortgage and will be responsible for the loan’s repayment.
Co-Signer. A co-signer on a mortgage loan may be needed if the primary borrower’s credit score or income is not sufficient for that person to qualify for the mortgage on their own. In this case, a cosigner with sufficient credit score and income may be allowed. The cosigner becomes responsible for repayment of the entire loan balance if the primary borrower defaults on the loan and can’t repay the debt.
Debt-To-Income (DTI) Ratio. DTI is your total monthly expenses divided by your total monthly income before taxes. Lenders will calculate this to determine if you’ll have the funds to repay the loan. Lenders typically require a DTI from 36% to 43%.
Conventional Loan. A conventional loan is one that is not a government-backed loan. There are two types of conventional loans, conforming and non-conforming.
Conforming Loan. A
conforming mortgage loan is one that satisfies the terms and conditions set forth by Fannie Mae, Freddie Mac, and their regulator, the Federal Housing Finance Agency (FHFA).
Non-Conforming Loan. This type of loan doesn’t meet the terms and conditions set forth by Fannie Mae, Freddie Mac. Examples include jumbo loans which have a higher loan limit for the purchase of higher priced properties.
Government-Backed Mortgage Loan. These loans are insured by the federal government and were created for first-time homebuyers, seniors, low-income individuals, those with bad credit, and borrowers with other unique circumstances. Examples of government mortgage loans include FHA, VA (Veterans Administration), and USDA.
Interest Rate. This is the amount (expressed as a percentage) charged by a lender on the loan amount given to a borrower.
Annual Percentage Rate (APR). The APR on a mortgage loan includes the interest rate, plus any additional fees including mortgage broker fees and “points” (an upfront fee that a borrower can pay to reduce or buy-down the interest rate).
Principal. This is the amount borrowed when the mortgage is taken. For example, all mortgage payments include principal and interest, meaning that each payment you make will decrease the principal amount owed on the loan, and pay some of the interest owed as well.
Homeowners Insurance. All lenders require the borrower to have home insurance, which the homebuyer will need to purchase prior to closing on a home purchase.
Private Mortgage Insurance (PMI). Conventional loans with less than 20% down require PMI be paid as part of the monthly mortgage payment to protect the lender if the borrower fails to repay the loan. With a down payment of 20% lenders won’t charge PMI on a new mortgage. For existing homeowners, PMI may be removed once 20% equity in the home is reached.
Amortization. This is the paying down of the mortgage loan over time, with each payment that is made. Some mortgages, including interest-only loans, do not fully amortize because only the interest portion is paid down and the principle amount is still owed.
Down Payment. This is the amount of money that a home buyer or property buyer “puts down” to secure an offer that has been accepted by the seller. This is also called “earnest money,” which tells the seller you are committed to the purchase. Depending on the type of mortgage a buyer gets, additional down payment money may be required by the lender.
Escrow. When a buyer’s offer is accepted along with the earnest money down payment, the money will be put “into escrow” and held until the time of closing, and deducted from the total owed on the home purchase. At closing, the money in escrow will be released to the seller.
Escrow Account. This is an account that the lender or mortgage servicing company uses to pay the borrower’s property tax and homeowner’s insurance. For example, a homebuyer with fixed-rate conventional mortgage will send a monthly mortgage payment and the money will go toward the principle and interest, and some will go into an escrow account that pays the property taxes and homeowners insurance. The escrow account process ensures that these items will be paid on-time and reduces the risk of non-payment or late payment.
Mortgage Note. This is a legal document that states the terms of the mortgage loan and the amount owed. The borrower signs this document at closing to acknowledge the obligation to repay the loan according to the specified terms.
Property Taxes. All properties have a taxable value that is paid to the county in which it is located. Property taxes may be calculated at a different rate depending on the county and state. Property tax payments are typically incorporated into the monthly mortgage payment and drawn from an escrow account that is established at closing.
Mortgage Requirements
Each lender has unique requirements for borrowers. These are some typical requirements:
- Down Payment
- Credit Score of 580 or higher
- Proof Of Income
- Proof Of Employment
- DTI Ratio between 36% and 43%
How to Get a Mortgage
Getting a mortgage can be easy, as long as you’re prepared. Here are some mortgage basics.
- Gather your documents. This includes paystubs/proof of income, W-2s or 1099s, proof of debt, and proof of assets.
- Check your credit score. Knowing your credit score before you apply for a mortgage can save you time. If you find your credit score is low (below 580), you’ll likely need to build your credit score to qualify for a mortgage. Check it for free here.
- Get pre-approved for a mortgage. Start by talking to a mortgage loan professional about your homeownership goals. To get pre-approved, you will need to provide the documents mentioned above, and the mortgage professional will ask your permission to check your credit score. Once approved, you will receive a “pre-approval letter.”
- Find the house you want. Bring your pre-approval letter (or a copy) when you shop for a house. Home sellers and real estate agents often prefer to work with buyers who are pre-approved for a mortgage, and your offer will be looked at more favorably.
- Apply for the mortgage. Once your offer is accepted you will complete the application process that includes getting an appraisal on the home, and other steps that your mortgage professional and real estate agent can guide you through.
- Closing. Once your application is approved, the loan is clear to close. These days, many closings are done virtually with funds wired to the seller. A Title Company, chose by the seller, will typically manage the closing.
Where to Get a Mortgage
There are several kinds of lenders that offer mortgages and home loans, including credit unions, banks, and online lenders. However, credit unions, including Credit Union of Southern California, are often the preferred choice for several reasons, including low interest rates, low or no fees, and lower closing costs. Learn how to choose the right mortgage lender.
Why Savvy Consumers Choose CU SoCal
For over 60 years CU SoCal has been providing financial services, including mortgages, Home Equity Loans, HELOCs, car loans, personal loans, credit cards, and other banking products, to those who live, work, worship, or attend school in Orange County, Los Angeles County, Riverside County, and San Bernardino County.
Please give us a call today at 866.287.6225 today to schedule a no-obligation loan consultation with a CU SoCal Member Services specialist.
Get Started on Your Mortage Today!