Buying your first home is one of the most exciting things you can do. It’s a chance to own your own piece of the world and make your mark. It can be a place where you raise a family and you set your dreams free. Buying your first home can also be overwhelming when applying for a mortgage, but it does not have to be, if do a bit of research first.
A mortgage is a legal agreement with a lender to payback a certain dollar amount with interest using the asset as collateral. Your new home is the collateral and you are entering into a legal agreement with the bank to pay back the loan over a specified period. Mortgages have a few variables that determine the monthly amount due:
Amount to be financed: This the total purchase price of the home less down payment
Interest Rate: Rate payable to the bank for borrowing the money
Period: Length of time of the loan
These simple components make up the mortgage, but there are lots of options when deciding the right type and payment terms for you.
The monthly amount you can afford for your mortgage is dependent on your individual financial circumstances and can be discussed at length with your lender. However, there are a few general guidelines to consider when planning your future purchase. How much can you afford from your budget on a monthly basis? Generally, is it recommended that you spend no more than 25% on housing. How much is your down payment? More is always better and you can get a mortgage with zero down payment, but conventional wisdom recommends between 10% and 20%. Check out this mortgage calculator to see some options.
The interest rate provided by the bank will be determined based on current rates set by the Federal Reserve, your personal credit history and your down payment. Additionally, you may choose a fixed rate (same rate entire period) or a variable rate (changes dependent on market conditions). Traditional mortgages have been for 30 years originally designed under the concept of having your home paid off at retirement. Today mortgage periods can range from 10 years to 45 years in extreme cases. Depending on your age, income and desire to pay off the mortgage quickly a 15 year loan might be more beneficial for you.
There are different types of mortgages that can best fit your personal circumstances both short term and long term. As discussed a traditional mortgage requires 20% down payment, but there are some programs designed to provide access to housing with less.
Federal Housing Administration has been providing housing solutions to Americans since 1934. A down payment of only 3.5% is required, but two private mortgage insurance premiums are required. Private mortgage insurance is an insurance for the bank to manage the risk of owner default. If you are able to put down less than 20% down payment you are considered “more risk” financially than an individual with 20% down.
Adjustable Rate Mortgages generally have a fixed rate for a period of time and then adjust to the market. This can be beneficial when getting into a home during a low interest period with the initial rate or if you plan to move after a few years. These are described as 5/1, 10/1, with the first number being the number of years at a fixed rate and the second as how often the rate will change. 5/1 means the rate will be fixed for five years and then change each year after that.
Balloon Mortgages are fixed rate. They have lower monthly payments at the beginning of the period with a large (balloon) due at the end of the period. These can be great for very fiscally responsible homeowners, but can be challenging if you want to stay in your home and cannot afford the balloon payment at the end.
Completing all the paperwork and analyzing all the prospective deals can be work. Here is a quick list of things you will want to have available prior to applying for a mortgage.
- Prior year w-2
- Know your credit score
- Basic identification information for both applicants (social security numbers)
- Estimate of your down payment amount