Owning your own home is part of the American Dream. It means setting roots, taking on new responsibilities, and finally having neighbors you don’t share walls with. But like the American Dream, owning your own home takes effort. And the work starts by taking time to understand the basics of a mortgage loan.
Getting Back to Basics
If you’re going to borrow money to buy a home, it’s important to understand what you’re signing up for. A mortgage loan is an agreement between you and your lender. The lender agrees to give you money to buy and take possession of a new home. And you agree to pay back the money over a set period of time with interest. If you default (fail to pay your mortgage payments), your loan is secured by the property, giving the lender legal claim to the home. Essentially, the basics of a mortgage loan involve you, a lender, a property, and a payment plan with interest.
Choosing a Lender
Because your choice in lender is the start of a 10- to 30-year relationship, it’s important to go with someone you can trust to provide helpful advice and quality service. Compare lenders to find the best balance of rates, fees, conditions, and communication styles that fit your lifestyle. According to research from Freddie Mac, making just one comparison call could save you $1,500 over the life of your loan. And more comparison calls usually means more savings.
Securing an Interest Rate
Several factors can influence the interest rate on your mortgage loan, including your credit score, down payment amount, loan term, and interest rate type (adjustable or fixed). Even external market factors can impact rates. Let’s consider each item one at a time.
- Credit Score – Your credit score is used to assess your ability to make future loan payments. If you have poor credit, lenders are more likely to shy away from loaning you money. You may still be able to get a mortgage loan, but your interest rate will likely be higher based on perceived risk.
- Down Payment – As a general rule, the higher your down payment, the lower your interest rate will be. If you can manage to put down at least 20% of your home’s price or appraised value, your interest rate may be lower and you may not have to pay insurance premiums.
- Loan Term – Your interest rate may change depending on the amount of time you borrow money (usually 10, 15, or 30 years). Again, it comes back to perceived risk. Shorter loans usually have a lower risk of default. So, if you can pay off your loan in less time, your lender can offer you a lower interest rate in return.
- Rate Type – Mortgage loans typically come with either a fixed or adjustable interest rate. A fixed interest rate stays the same for the life of your loan and locks in prior to your loan funding. Adjustable interest rates, on the other hand, are usually lower at first, but can change after an initial period, depending on market rates.
- Market Factors – Finally, interest rates can rise and fall in response to other market factors. Things like inflation, overall employment rate, stock market conditions, government borrowings, and even gas prices can cause interest rates to go up or down. And they usually do so in connection with the interest rates set by the Federal Reserve. So, even though fixed interest rates will remain fixed for the life of your loan, prior to locking in your rate they are susceptible to fluctuation depending on the market.
Believe it or not, a mortgage (and the home that comes with it) can be your key to freedom and future prosperity. But it’s certainly not something you should take lightly. By understanding the basics of a mortgage, including the importance of finding the right lender and the factors that affect interest, you’re well on your way to finding a new home and your piece of the American Dream.