“Before you say anything, I need to sit down. I got sticker shock while looking at Zillow. How the f@&# can I afford a home?!"
Maybe you’ve always dreamed of hosting friends for cocktails on the terrace of your very own sleek downtown condo. Or maybe it’s snuggling with your sweetie in front of the fireplace in a colonial surrounded by a white picket fence. Everyone has some picture in their mind’s eye of their perfect home. And though you can also picture how the home buying process will play out, many first-time buyers end up stumbling blindly through the process. Would you sign up for a marathon without training for one? Of course not. (But kudos to you for thinking about it.) The same principle applies to doing your financial homework before you start browsing Trulia, Zillow, or Redfin.
Just as every marathon begins with a single step, let’s start the process by talking about mortgages. In non-tiny-print speak, a mortgage is simply a loan from the bank that allows you to buy something that you don’t have enough cash to pay for outright. In return, the bank holds your home as collateral in case you stop making payments, or default, on your loan. If you’d like to get really technical: the mortgage itself isn’t the loan, but the legal document that states your home is collateral in the event you can’t pay back that loan. Once the loan is repaid in full, you own the property outright and both you and the bank can say, “Smell ya later.”
Think of your mortgage as a key -- pun intended -- because snagging a mortgage unlocks your ability to afford a home. You’ve played around with one of the many online mortgage calculators, and you might already know that your credit score, a low debt load, and a 20% down payment will help secure the best mortgage terms. But let’s demystify a few more concepts before you start calling lenders:
Interest rates versus APR: Is the bank purposely trying to confuse you by listing these two percentages side by side? Your interest rate is the percentage the bank tacks on to the principal amount you borrow - you’ll need to know this number if you’re trying to calculate potential monthly payments. APR, or Annual Percentage Rate, is a broader and more accurate measure of what you’ll pay for your mortgage loan. It’s higher than your interest rate because it figures in broker fees, discount points and other charges associated with the loan. Generally, a higher APR means higher monthly payments, though it’s not what your monthly payments are based on. We’ll talk about these more in depth.
Types of Mortgages: Everyone likes to have choices, so we’ll cover a few of the most common mortgage types. Just like their names imply, a fixed-rate mortgage offers a fixed interest rate throughout the life of the loan, while an adjustable-rate mortgage is fixed to a lower interest rate at the start of the loan before “adjusting” to interest rate changes over the course of the loan. There are pros and cons for both, and we’ll discuss them next.
Amortization: Nope, not a medical procedure. When it comes to buying a home, amortization is the process of paying down your principal in regular installments spread over the term of the loan. You’ll frequently see amortization schedules that show how your principal decreases over time. At the beginning of your mortgage term, however, a substantial chunk of your monthly payments go towards paying down interest first; and then over the life of the loan, you pay more principal down. Well played, banks.
Know who to speak with to get your best terms: You could spend an afternoon emailing and calling several banks to find out their mortgage rates, or you could save time and call a recommended mortgage broker. A loan officer is associated with a particular bank; so when you’re hitting up different banks, you’ll connect with a different loan officer for each. When you apply for a mortgage, that bank originates the loan and you are locked into their rates, which could be the best terms offered by that individual bank, but not necessarily the best rate available. A mortgage broker, on the other hand, works independently of a bank, but has relationships with many banks. Your mortgage broker isn’t a lender, but will connect you with the bank offering the best rate.
Like real estate agents, not everyone you work with will give you the best terms for you. A few tenths of a percentage point still add up over the years, which is why it’s so vital to shop around for the best rate.
A mortgage is another monthly payment-- sometimes a jumbo one-- but if you’ve done your math correctly, you can make it fit within your budget. Don’t panic when you look at those lofty numbers!
This article is 1st in the Mortgage 101 Series