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Mortgage Basics


Mortgage Types

Mortgage loans can be classified several different ways:  

Conventional vs Government Backed

A conventional loan is not insured by the government and the lender assumes the risk if the borrow. Most mortgages are conventional and to get the best interest rate, you typically need to put 20% down. Some lenders will have a conventional loan with a 5% or 10% down option. 

A government backed loan is insured (in the case of an FHA loan) or guaranteed (in the case of a VA loan). The government does not lend money to the borrower; instead, it promises to repay some or all of the money to the lender in the event that the borrower defaults. This reduces the risk for the lender when making a loan. Most lenders will offer conventional and government backed loans, which can have lower credit score requirements and down payment requirements. The downside is that there is usually mortgage insurance to pay each month and an initial funding fee paid at settlement.

Fixed vs Adjustable Rate

A fixed rate mortgage will have the same interest rate throughout the life of the loan, which also means your payment will remain the same. Adjustable rate mortgages (ARMs) adjust after some time period. Many ARMs are hybrid loans - they may be fixed for a number of years (3,5,7 or 10 are popular) and then adjust yearly after that.

Loan Term

Loan term refers to the length of the loan. 30 years is the most common and 15 years is the second most popular.

Interest only vs Amortized

With an interest only loan, you are only paying the interest on the loan each month and the principal is never reduced. This makes for a lower monthly payment, but at the end of the loan term, you still owe the same amount you with which you started.

An amortized loan is eventually paid off at the end of the loan term. Part of your monthly payment on an amortized loan will go towards the principal and part will go towards the interest.

A few interesting notes about amortization:

  • After 10 years only 16% of the principle has been paid off on a 30 year loan.
  • On a 30 year loan at 6% for $250,000, the borrower will pay $290,000 in interest over the life of the loan.
  • Making one additional payment per year will reduce term by 5.3 years

Size

The size of the loan is categorized as:

Conforming - Currently, loans up to $417,000

Conforming Jumbo - For conventional loans, the current limit is $625,500 and FHA limit is $729,750.

Jumbo - Loans above the conforming jumbo limits.

Unless you are paying cash for your home, getting pre-approved is a critical first step and it is far better to pre-approved than pre-qualified. Knowing what you can afford will save you valuable time and increase your bargaining power when you find the right place. Get pre-approved today.