Mortgage 101 — Breaking Down The Basics

mortgage 101

Be confident in understanding the fine print when it comes time for your signing appointment.


The common questions many first-time buyers ask are now answered.

Purchasing a home and conquering financial responsibility is a goal for many people. But making this leap to homeownership is a big step, and it’s one that should be taken with careful consideration. Let’s face it, finding a home and securing a mortgage isn’t a walk in the park — and certainly nothing like signing a simple rental agreement. You’ve probably encountered confusing jargon such as “points,” “preapproval,” and “prequalification,” and funny names like Fannie Mae. And did you know that it’s almost always cheaper to buy than rent? Making sense of everything can leave you on the verge of frustration, but don’t worry — this is a completely normal feeling.

To help you demystify the process and get the most out of your first mortgage, we’ve asked some finance experts about things to consider before applying, some common points of confusion, and a few handy tips to help you understand the basics of mortgages.

What’s your best advice to a first-time homebuyer?

“Be prepared; do your homework. Check out reputable lenders in your area. Get prequalified so that you know the price range in which you should be shopping.” — Cathy Blocker, EVP, Production Operations of Guild Mortgage Company

“Talk to a local mortgage banker that you’re comfortable with! There are some great mortgage bankers willing to help, so you shouldn’t waste your time with someone who doesn’t make you feel comfortable with the process. Explain what you’re looking to do and what your ideal home-buying situation is. The right mortgage banker will customize your home loan to your specific scenario. Make sure they explain all the costs ahead of time, so that you know exactly what to expect once you get a purchase contract and start the mortgage process.” — Nick Magiera of Magiera Team of LeaderOne Financial

What should buyers be prepared for when applying for a loan?

“Every mortgage situation is different, so there’s really not a one-size-fits-all list of requirements. I recommend that you contact a mortgage banker that you know, like, and trust. If you don’t know any mortgage bankers, then I recommend that you choose a mortgage banker that your real estate agent suggests you work with. Your real estate agent wants you to have a smooth transaction, so they will only send you to mortgage bankers that they trust. A great mortgage banker will then walk you through the process and customize the mortgage around your specific scenario.” — Nick Magiera of Magiera Team of LeaderOne Financial

“There are a few things to get squared away before applying for a loan: 1. Cash for a down payment. Save money/acquire money for a down payment and closing costs. 2. A good working knowledge of your personal finances. Create a budget of your future expenses, as if you own the house, and make sure you can afford it. A good rule of thumb is that your mortgage should not exceed 30% of your take-home income. 3. A general idea of the price range of homes you are interested in. Research potential homes through a local Realtor or at Trulia.com. Compare by looking at real estate taxes, neighborhood statistics, and other criteria. Take your time! Your house may be the largest purchase in your life.” — Scott Bilker of DebtSmart

What is the value in getting preapproved or prequalified for a mortgage?

“It gives homebuyers an edge against competing offers. If a seller sees two offers and one has already been approved, then that is often the one that they go with, as there is less risk for them.” — Tracie Fobes, Penny Pinchin’ Mom

“First off, there is a difference between preapproved and prequalified. Prequalifying means you have done an initial lender screening. However, preapproval is the next step in the process. You have to give the bank many more documents like you’re applying for the mortgage. It’s worth doing because you will get a preapproval letter from the bank, and this will show sellers and real estate agents that you’re a serious buyer. It will also give you a better idea of which homes you can afford. Additionally, you will be able to act quickly once you find that perfect place without having to then seek out financing.” — Scott Bilker of DebtSmart

What range of rates should a first-time homebuyer expect with either a poor credit score or a strong credit score?

“On a conventional loan (Fannie Mae or Freddie Mac), the difference in price between a poor credit score (620) and a strong credit score (740-plus) could be as much as 3.0 points in fees, or 0.75 to 1.25% in interest rate. On an FHA or VA loan, the price difference may be up to 0.75 in points in fees or 0.125 to 0.250% in interest rate.” — Cathy Blocker, EVP, Production Operations of Guild Mortgage Company

“There is not a single universal standard. Lenders determine what kind of risk premium it will add to a loan based on your credit history and other information presented in a loan application. You can’t take a lender’s advertised interest rate for its best-qualified borrowers and tack on a set premium because you’re a C credit instead of an A credit (A credit being the least amount of risk).” — Nick Magiera of Magiera Team of LeaderOne Financial

What are some tips for paying off your mortgage faster?

“There are only two ways to pay off your mortgage fast: 1. Refinance at a lower rate. 2. Pay more toward the mortgage. That’s it. Don’t be fooled by biweekly mortgages because all they do is make you pay more. If you are not in a position to get a lower rate, then simply increase your monthly mortgage payment to an amount that is comfortable, keeping in mind that this is money you cannot easily get back. Conversely, if you pay more on your credit cards, you can always use the card again for cash or to buy things you need.” — Scott Bilker of DebtSmart

What does it mean when “the Fed raises the rates,” and how does it apply to mortgages?

“[The] Federal Reserve sets the interest rate that banks pay to borrow overnight funds from other banks holding deposits with the Federal Reserve. If the cost of overnight borrowing to a bank increases, this typically causes banks to increase the interest rates they charge on all other loans they make, to continue to earn their targeted return on assets. As banks increase their interest rates, other lenders or financial firms also tend to increase their rates. An increase in the federal funds rate does not directly correlate to a direct increase in mortgage rates but is viewed as a general signal to the market that the Federal Reserve views that the economy is growing and that interest rates will be increasing in the future.” — Cathy Blocker, EVP, Production Operations of Guild Mortgage Company

What are points?

“Points are fees the borrower pays the lender at the time the loan is closed, expressed as a percent of the loan. On a $200,000 loan, 2 points means a payment of $4,000 to the lender. Points are part of the cost of credit to the borrower, and in turn are part of the investment return to the lender. That said, points are not always required to obtain a home loan, but a ‘no point’ loan may have a higher interest rate.” — Nick Magiera of Magiera Team of LeaderOne Financial

“‘Discount points’ refers to a fee, usually expressed as a percentage of the loan amount, paid by the buyer or seller to lower the buyer’s interest rate.” — Cathy Blocker, EVP, Production Operations of Guild Mortgage Company

mortgage 101 tips

What’s the difference between Fannie Mae, Freddie Mac, and other government-sponsored enterprises (GSEs)?

“Fannie Mae and Freddie Mac are the two most common GSEs buying mortgages from banks and mortgage lenders. Though separate companies which compete with one another in the same market, they have the same business model and very similar guidelines and documentation requirements.” — Cathy Blocker, EVP, Production Operations of Guild Mortgage Company

“Fannie Mae and Freddie Mac are government-sponsored enterprises — they are private companies sponsored by the government in the U.S. home mortgage industry. They are separate companies that compete with one another and have very similar business models. They buy mortgages on the secondary mortgage market, pool those loans together, and then sell them to investors as mortgage-backed securities in the open market. There are subtle differences, but the main difference between Fannie and Freddie comes down to who they buy mortgages from: Fannie Mae primarily buys mortgage loans from large commercial banks, while Freddie Mac mostly buys them from smaller banking institutions (thrifts). Bottom line, their primary function keeps money moving through the U.S. housing economy, allowing people to afford the purchase of a home, which would otherwise be impossible if Fannie and Freddie were nonexistent. Ginnie Mae essentially performs the same function as Fannie and Freddie, except they focus on government-insured mortgages such as FHA and VA.” — Nick Magiera of Magiera Team of LeaderOne Financial

What are additional costs of ownership that a first-time homebuyer should be prepared for?

“Besides principal and interest, property taxes, hazard insurance, and homeowners’ association fees (if applicable), there may be private mortgage insurance for a conventional loan or monthly mortgage insurance for an FHA loan. Homeowners should also be prepared for the costs of repairs and maintenance of the home, particularly if purchasing an older home.” — Cathy Blocker, EVP, Production Operations of Guild Mortgage Company

“In addition to taxes and/or homeowners’ association fees, utilities, and the like, there will inevitably be a host of little fixes here and there that will add up to a lot of cash. When I got my house, it wasn’t long before the basement flooded, and it took thousands to install a French drain system. There is always something that needs attention, and the costs can add up. So be sure to plan for these situations. That means when buying a house, buy less, much less, than you can afford — this way, you’ll be in good shape when (not if) things need maintenance.” — Scott Bilker of DebtSmart

What documentation does a buyer need to solidify a mortgage quickly and efficiently?

“Every home purchase varies, but here’s a list of the most common documents that we’ll need to verify: Past two years of tax returns, past two years of W-2s or 1099s, past two months of bank statements, past 30 days of pay stubs, copy of your driver’s license, copy of either your passport or Social Security card.” — Nick Magiera of Magiera Team of LeaderOne Financial

Is homeowners insurance optional?

“Not if there is a lender involved. Even then, not having homeowners insurance is like swimming without a life raft. Sure, you may not drown, but imagine what would happen if you started to sink? You need something there to protect you.” — Tracie Fobes, Penny Pinchin’ Mom

“No, no, and definitely no — it’s not optional. You always want homeowners insurance because anything can happen, and it will, from hailstorms that can chip away at your siding to high winds and flooding, plus other unforeseen accidents. As a homeowner, you need protection, legal and financial protection, from situations that you cannot even imagine. So it’s best to play it safe and get homeowners insurance. You have been warned.” — Scott Bilker of DebtSmart

 

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