Mortgage basics for the first-time homebuyer

Mortgage hunting may be as important as house hunting, if not more so. Finding your dream home is just the first step in the process. The second step is finding the right mortgage. Learning the basics about mortgages now may help you move through the process more confidently when the time comes.

Learn the lingo

A mortgage is a loan you apply for and use to help pay for a home. The home is then used as collateral—if you don’t make your mortgage payments, the lender can take away the home to cover your missed payments. When researching mortgages, it helps to know a few basic terms:

• Principal: The amount you borrow to purchase the home.
• Interest: What the lender charges you to use their money. It is a percentage of the principal based on current economic indicators.
• Term: The length of the loan—for example, 15 or 30 years.
• Amortization: The total of the principal and interest, divided into equal payments over the life of the loan. Typically, your initial payments cover mostly interest, and your later payments cover more of the principal. 

Gather information

Information is power when you’re shopping for a mortgage. Before you begin investigating mortgages, investigate your own situation.

1. Request a credit report so you know where you stand in the eyes of lenders. If your credit score is lower than you’d like, there are ways to improve it. Read What you need to know about your credit score to learn what your credit score means and how it’s used.
2. Look at your cash savings. Do you have enough saved for a potential down payment and closing costs? If you have the time, you may want to consider putting some of your money in short-term investments, which may generate higher returns than a checking or savings account.
3. Determine how much house you can afford. Though a home is an investment, you don’t want to bite off more than you can chew financially. Use an online calculator to estimate how much you may be able to afford. 

Find a lender

Once you have a handle on your financial situation, it’s time to contact potential lenders to learn what type of mortgages they offer. Lenders include banks, credit unions, and mortgage companies. The more lenders you contact, the larger selection of mortgage products and terms you have to compare. If you want assistance, mortgage brokers can also do the legwork of finding multiple lenders; just beware of broker fees, which can be tacked onto your closing costs, your interest rate, or both. Plus, mortgage brokers are not obligated to find the best deal for you unless you have contracted with them as agents.

Obtain cost information

As you’re speaking with potential lenders, you’ll want to understand all cost components of their mortgage options. Be sure to ask about:

• Rates. Get a list of current mortgage interest rates. Clarify if the rates are quoted for the day or week and whether they are fixed or adjustable. Fixed rates stay constant throughout the term of the loan and are generally higher, whereas adjustable rates start out lower but can fluctuate based on market conditions over the life of the loan. Finally, find out about the loan’s annual percentage rate (APR). The APR takes into account not only the interest rate but also points (described below) and other charges you may have to pay, expressed as yearly rate.
• Points. Points are fees paid to the lender or broker for the loan and are linked to the interest rate. The more points you pay, the lower the rate. Request that you get points quoted to you in a dollar amount, so you’ll know how much you’ll be paying.
• Other fees. Mortgages may involve other fees, such as loan origination fees, underwriting fees, and transaction, settlement, and closing costs. Be sure to clarify what fees the lenders charge and what the fees include, and ask for an explanation of any fee you don’t understand. Fees are often negotiable, and they can be paid directly or added to the amount of the loan.
• Down payments and PMI. Down payments typically range from 5% to 20% of the home’s purchase price, depending on the type of loan. If your down payment is less than 20%, you may be required to purchase private mortgage insurance (PMI) to protect the lender in case you fail to make payments. Make sure you understand the lender’s down payment requirements and how to verify that funds for your down payment are available. If PMI is required for your loan, ask what the total cost of the insurance will be, how long you will be required to carry it, and how much your monthly payment—including the PMI premium—will be.

As a first-time homebuyer, you may also be eligible for a first-time home buyer’s mortgage or government assistance. Some benefits of these programs include little to no down payment, subsidized interest costs (where a third party pays the interest), and limited fees. However, some of these options come with restrictions. Be sure to ask each lender what programs might be available to you. You can also visit the “Buying a Home” section of the U.S. Department of Housing and Urban Development to learn more about first-time homebuyer options in your area. 

Negotiate

After you have the information you need, use it to compare the costs and terms of the different loans and get the best deal. There’s no harm in asking lenders or brokers if they can provide better terms than what they originally quoted or those you have found elsewhere.

To start negotiating, have the lender write down all the costs associated with the loan. Then ask if the lender will waive or reduce one or more of its fees or agree to a lower rate or fewer points. However, make sure the lender isn’t agreeing to reduce one fee while raising another or to reduce the rate while raising points.

Once you are satisfied with the terms and have selected a lender, you may want to obtain a written lock-in. For a fee, which may be refundable at closing, you can guarantee a mortgage rate for a specified period of time. Lock-ins can protect you from rate increases while your loan is being processed; if rates fall, however, you could end up with a less favorable rate. Try to negotiate a compromise with your lender if that happens.

Complete the application process

Once you’ve selected a lender, it’s time to complete the mortgage application process, which verifies your ability to repay the loan. The application can usually be done online, over the phone, or in person, and can take up to eight weeks to complete. You’ll need to provide your home’s purchase price and down payment amount, which is then used by the lender to determine whether the home you want to buy can serve as collateral for the amount of money you wish to borrow. You’ll also need to provide personal employment, income information, and credit history. The lender will request a professional appraisal of the value of the property you’d like to buy, and you’ll need to complete and sign a number of required forms.

Move forward

When your mortgage application has been approved, you’ll typically receive a commitment letter as notification. The letter will inform you of the approval amount, whether it’s for the whole amount requested or a portion of it. You’re now ready to take the most exciting step: purchasing your dream home!

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