Mortgages use all sorts of lingo and (somewhat) complicated math to help you buy a home. Making the right decision on a mortgage will have a greater financial impact on your life than the size of your drink at the movies, so listen up.
A fancy word for the loan you need to buy your home. If you have $15,000 in hand to pay for a $150,000 home, you'll need a $135,000 mortgage to make up the difference.
Length of a mortgage. It's usually 15 or 30 years long (though you won't necessarily keep it that long). If mortgages were shorter, like 5 years, your monthly payments would be much larger.
The money that comes out of your pocket to pay for your home. This money acts as a "cushion" if you happen to flee to Ecuador and they're forced to sell your home for less than what you paid.
Before shopping for a home, you can get "pre-approved" for a loan of a certain amount. This will help you rule out the 65,000 square foot homes on the water.
The interest rate and fees for your mortgage will vary from lender to lender, so it's a good idea to shop around. Visit local banks, contact a mortgage broker, or compare rates online.
When comparing interest rates, be sure to look at the APR (annual percentage rate). This rate includes all fees charged by your lender, allowing you to fairly compare different offers.
Once you've found your home and agreed on a price, you'll go to "closing" to sign the paperwork. And of course, there are more fees to pay (closing costs).
Closing costs come in a variety of shapes and colors. You may encounter points, discount points, application fees, credit report fees, appraisal fees, inspection fees, and so on. Most of these will be due at your closing (on top of your down payment -- yippee). Your real estate agent will provide you with a list of all of these costs before closing.
Types of Mortgages
Your monthly payment stays the same every single month. Even if mortgage rates go up or down, your payment stays the same.
Adjustable-rate mortgage (ARM):
Your payment will go up or down based on current interest rates. A "5/1 ARM" or "10/1 ARM" means that your rate is fixed for 5 or 10 years but then adjusts up or down every 1 year after that.
Oh-Shoot!-I-Can't-Afford-My-Payments-Anymore mortgages (OSICAMPAMs):
Crazy mortgages that involve low initial payments that turn into much larger payments as time goes on (interest-only loans, balloons, and so on). Beware.
The Down Payment Hurdle
The money you have to pay out of your pocket when you buy a home.
Some lenders require that you make a down payment of at least 20%. If that's too steep, you'll probably have to purchase mortgage insurance. This can go by a number of different names (none of which we'd recommend as a name for your first child): PMI, MIP, and MMI.
By purchasing mortgage insurance, you may be allowed to put down as little as 5% of the purchase price. This fee can usually be included in your monthly mortgage payments.
If a 5% down payment is still too much, you many want to see if you quality for a government-backed mortgage from the FHA (Federal Housing Authority).
What's yours. If you put $15,000 "down" to purchase a $150,000 home, $15,000 is your equity. Although you own the whole house, the rest of it isn't really "yours." If you sold your home tomorrow, you'd have to pay back the $135,000.
Here's the cool part: If the value of your home goes up by $5,000, all of this "appreciation" is yours. In fact, percentage-wise, this appreciation can sometimes be pretty significant. If you initially put down $15,000 and you make $5,000, your equity has appreciated by 33%. Ka-ching.
But here's the not cool part: If the value of your home goes down by $5,000, all of this "depreciation" is yours. To make matters worse, if the value drops by $20,000 (and you've put down $15,000), you actually have $5,000 of "negative equity." You owe more money to the bank (with your mortgage) than the house is actually worth. Joy!
When you make a mortgage payment, some of your money will be used to pay interest, and the rest will be used to pay off what you borrowed (the principal).
Interest adds up. For example, let's suppose you take out a 30-year mortgage for $135,000 (6% interest). If you make regular payments, you'll pay roughly $290,000 over 30 years (over twice the principal amount) due to interest.
Your payment is constant, but the amount allocated to interest and principal changes. As time goes by, more and more of your payments will go toward paying off your principal as less and less will be needed to pay interest.
If you can afford it, pay more than your required mortgage payment (prepayment). All of your extra payment will go towards reducing your principal and reducing the length of your mortgage. That means that you'll stop paying sooner.
Bert was a lonely guy. He lived alone. He worked in a cubicle alone. He showered alone. When he tried to get attention by posting his phone number on a billboard, he couldn't even get a crank call.
Bert was so depressed that he stopped paying his bills. A few days later, he received a phone call. It was his mortgage company telling him that his payment was overdue and that he'd be evicted if he didn't send money immediately.
Bert had a friend. It was the happiest day of his entire life.