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How do mortgages work?

My high school never taught me anything about mortgages, loans, debt, credit or any of that stuff that I will need in life. I am planning to move out of my parents home, but I have no idea how mortgages work and I want to get a house. #house-plans #mortgage #financial-planning


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Dien’s Answer

Ronaldo;


A mortgage is a binding obligation between a lender (Mortgagee) and a borrower (Mortgagor) which the lender agrees to lends money to the borrower by securing a real property (often a residential dwelling). To qualify for a mortgage loan you need to meet the lender requirement (underwriting guideline). This requirement includes the following conditions, lenders call them the 5 C of credit

1) Character (the borrower credit profile, meaning the borrower credit worthiness)

2) Capacity (the ability to debt service, and repayment of the loan)

3) Capital (skins in the game, in general for a residential mortgage loan, the borrower is required to have at least 3% of the purchase price)

>4) Collateral (the dwelling)

5) Condition (term of the loan, i.e. interest rate, term...etc


So without knowing your current employment, credit, asset situation it's very challenging for me to provide you with good direction. So to better assist you, please answer the following questions:

1) are you currently employed? How long have you been working with the current employer?

2) how is your credit profile?

3) do you have any money saved up, or can you get gift fund?

4) do you have any monthly debt obligation? this includes every personal loan, credit card, car loan, alimony or child support, or any garnishments.

Once I get a better picture of your situation, I will be able to provide you with some direction.


I hope this help!


Thanks it was a detailed explaination Shak Syed

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LISA’s Answer

Hi Ronaldo -- It's great that you are asking these questions! There are some terrific answers already posted on the mechanics of how mortgages work so I won't repeat that. I would add that a starting point should be "why do you want to buy a home (rather than rent) at this point in your life?" Buying is not at all necessarily better than renting. Renting is very often a great option. So, as you learn about mortgages and the home buying process, also take the time to learn about when buying is, and is not, the best path. Post another question if you want to explore that some more!


Love this perspective! Totally agree Ezekiel Anders

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Shak’s Answer

Mortgages are secured loan against a residential or commercial property.

Meaning if the Loan is not paid the bank can take the property in foreclosure. To get qualified for a mortgage you need to understand the following.

1-You need 2 year of work history usually in the same industry to show stability of income.

2- good credit over 640 Fico score some banks will accept lower scores but they charge higher interest rate .

3. At least 3% down payment that could be your own money saved.or a gift from a close relative. You also need 4 to 6 months of. Property taxes and Insurance as escrow.

Escrow means the bank will hold 4 to 6 months of taxes and insurance in a account to pay, when taxes and insurance becomes due.

The stronger these three things are the lowest is the interest rate you pay.

Also you have to consider your personal situation if owning a house is something you can afford or manage. Its is the biggest financial commitment you will have and you have to be handy with minor repairs if that happens.

If you are just planning to move out of your patents home and has never rented before I would suggest that you do that just to see, If making a monthly housing pmt. Is something you can handle , Also do some reasearch go online Google first time home buyer programs, ask anyone you know how their experience was in buying a house.

There are several non profits that offer home ownership courses that can be done online or at the learning center.

Hope this helps, if you need detail financial analysis on what you can afford and how it will affect your finances & Taxes feel free to reach out to me. Good Luck







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Emmanuel’s Answer

The individuals who answered before me have great direct responses to your question. The question you posed seemed pretty open-ended, so instead of answering the question in the same way as everyone else did, I will answer it differently. I will discuss how payments are determined, and issues related to owning that you should consider before buying. Lastly, I will describe how your mortgage is funded, which I think is pretty interesting.

Many features make mortgages different from one another, but I will focus on the one that is common among them all. Most mortgages use a method to calculate how interest and principal are paid called "double-line amortization." I won't go into the granular details in this post, but focus on its implications on the "rent-versus-own" dilemma; which is a very important and rarely understood issue. A layman would think in terms of a "simple interest loan." The natural inclination would be to divide the principal payment EVENLY over the number of payments (360 in 30 year fixed) then add interest, so that you would pay equal proportions of principal and interest with each payment. As an example, if you had a mortgage of $200,000 and a 4% rate, you would simply divide the loan amount over your total number of payments, and add 4% (($200,000/360)X 1.04= $577). This is not the case at all, which gives people a false view that owning a home is always better than renting. With mortgages, the balk of the interest owed is front-loaded during the life of the loan, with equal parts principal and interest, not occurring until year 22 in a 30-year fixed mortgage!! In fact for the first 7 years of a 30-year fixed, your mortgage payments will go pretty much all go to interest. When all is said and done, you will pay about $2.50 for every $1.00 you borrow over the life of a 30-year fixed. This means that if you are in an unstable industry, want to retain the flexibility of moving, or don't plan on living in your home for 7 years or more, it will probably be a loss to break-even proposition at best.

Besides the mortgage payment itself you need to consider the total cost of ownership that can, in some areas of the country, exceed the mortgage itself:

-Insurance: Unlike Renter's which simply covers contents, liabilities, and loss of use, you will also need to ensure your structure.

-Property taxes: Each state charges homeowners a tax. (this will be taken along with your mortgage payment by the servicer) throughout the life of the loan.

-Repairs: Every young person is different, but for the sake of argument, let us assume you are not at the peak of your earning years, and will be looking at entry-level home in your budget, which are commonly older homes. With age comes needed repairs in which you will not be calling a landlord to fix. Some maybe tens of thousands and critical for your ability to live in your home, and some will be cosmetic, but they are costs nonetheless. Even if you move into a place that does not need repairs, you will still want to create a "sinking fund" for future repairs. This will help you address surprises quickly, or make improvements if circumstances dictate that you have to put your house on the market.

-Transportation cost: Generally the closer you get away from population centers, and perhaps work, the less homeownership will cost. However, the trade-off is the increase in time and cost to travel.
-Schools: This may or may not be a concern, but there is a direct relationship between house prices, taxes, and school performance. Your home may not be expensive, but does your public school meet your standards? Will you pay for a private school?

-Brokerage commission: This could be about 5% of the total value of your home, however, you can during buyer's markets, negotiate that the seller pays some or all of this.

-Opportunity cost: An opportunity cost is the value of what you will give up by making your baseline decision. Let us say for instance, you do very well at your career, so well that a recruiter sends you a request for an interview through linkedIn, for a job in Illinois that is double what you are making. This is an implicit cost of being stuck in Texas. Could you afford two housing payments!? What happens if your house doesn't sell, or you don't have enough equity!? Or, worse yet, imagine that a major layoff of a company in your local economy drives home prices lower. The spillover over into your industry, would lead to declines your income, raises, or a reduction instability of the job you have. Your home could be the only thing holding you back from a better life. In my opinion, this is the largest risk of homeownership for younger people as you have a smaller network, will not have as much seniority at your job, or time in your field that will greatly differentiate you in your job market yet.



The process:

You will go to a bank, or mortgage broker. As an individual you are creating a security, that is priced and evaluated by the market as a whole. They will determine your credit profile/ability to pay, and work as a middle person for the actual funders of your mortgage. Most of the money that is given to the person/bank you buy a home from is funded in 4 ways: Your downpayment; Institutional investors (i.e. mutual funds, banks, insurance companies, etc.); Government-sponsored entities (GSEs) who either fund or guarantee debts of independent investors (such as Fannie Mae, Freddie Mac, Ginnie Mae); and bank deposits from lending institutions. The mortgages funding options available are determined by the ratings given to a basket of mortgages, in which each investor decides how much risk and return they are interested in. The major delineation is between Sub-prime, and prime mortgages, with a "prime" rating conferring a lower rate, due to a borrower's higher credit rating.

All of these decisions are made in the background. The agreement is that mortgage broker/bank will receive an "origination fee", and perhaps a "servicing fee". Going rates for mortgages are updated and published daily by term (15-, 30-year, etc.) and funding source type (FHA, VA, Conventional etc.) (check out bankrate.com as an example). About 70-90% of the mortgage market is ultimately owned by the GSEs, and not the firm/bank you originate your loan through.

Ultimately, you are deciding between paying a banker or a landlord; there is no free lunch. Work with someone to help you crunch the numbers before you look at houses, and maintain a good cushion between your monthly income and debt. Try to stay under a debt service ration of 25%. As a rule of thumb, spend no more than a week's worth of income on housing. Start saving now and establish good credit behaviors. Then, determine if the areas you COULD buy-in are better than renting in your situation (there are plenty of calculators online.) Next, get pre-approved for a mortgage. Lastly, go on tours of homes. In this order, you can limit the impact that emotions will play in making a decision.

I hope this helps!

Very comprehensive! Ezekiel Anders

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Peggy’s Answer

This is a complicated answer as shown by previous posts - but the best thing for you to know is maybe not how the sausage is made but how do YOU get your first mortgage. Many lenders offer first time homebuyer tools and education which is a great way to learn about what the lender will require to lend you the money to buy that awesome home.

There are many loan programs to choose from based on your situation; we are all different and so are our credit needs and histories. A great basic to start with is how much can you afford and how much are you comfortable paying.

A good rule of thumb is to take your monthly gross pay (before taxes taken out) and multiply that amount by 28% - ex: $3,000 X 28%=$840. That should be the amount of house payment you should not exceed...NOW take that same $3,000 X 36%=$1,080 and this should not exceed your total house payment and recurring monthly debt - this is called Debt to Income Ratio (DTI).

Different loan programs can expand these ratios so be sure to check with the lender. Some loan programs allow you to put as little as 3% down payment but there will be mortgage insurance (a whole nuther topic) included in your total house payment - the total amount of a house payment consists of - Principal/Interest/Property taxes/Homeowners Insurance/Mortgage Insurance (if less than 20% downpayment).

Also a part of the mortgage process is closing costs which can really bring that cost to get into a home challenging. Please know you can receive a gift from parents or non-profit organizations for downpayment and closing costs but this must be fully documented. Also credit scores should be greater than 620 - the higher, the better interest rate you will receive (kind of the same thing for credit cards and auto loans).

These items should be first on your mind when thinking about the cost of renting vs. owning.

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james’s Answer

The most important things are to keep your credit score as high as possible to get a great interest rate/terms and save, save, save.

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Csaba’s Answer

That is a great question! You can think of a mortgage as a loan which is backed up by the value of the physical object (typically a house) that the loan is provided for. So in a simple example let’s say you plan to buy a house for $200K but you only have $20K of your own money. You would go to a bank to ask for a loan to cover the difference. The bank will first need to assess what they think the value of the house is that you want to buy and then they will also want to understand what your personal financial and employment situation is to understand how likely you will be able to payback the loan in the coming years. If everything checks out then they will issue you the loan (in the case of the example above it would be $180K) to complete the transaction. It is important to understand that typically you will have to pay monthly $ installments to repay the loan and there is a financial cost involved which is referreed to as loan interest which you need to pay to the bank above the principal loan value. Also important to know that the bank will have certain rights over the property (own title), for example if you want to sell the property the bank must be notified and anything you still owe will be deducted from the selling price. For further information you can find a good article here: https://www.realtor.com/advice/finance/mortgage-basics-what-is-a-mortgage/

My personal experience is that mortgage agreements are very complicated and have extensive legal language which is difficult to understand if you are not a lawyer so you should always have a financial or real estate advisor represent your interests and explain to you all the details before you sign any agreement.

Good luck and hope this was helpful!

Csaba recommends the following next steps:

As a next step please review the article I suggested

Like how it was explained Shak Syed

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Jennifer’s Answer

Buying a home is a great step towards building financial security, but the process can be very confusing and overwhelming. There are many government agencies, and local groups that can provide you with mortgage education, home-ownership counseling and support, and help you structure your finances to make sure you get the best mortgage for your needs.

A mortgage is a large commitment so I suggest that you take your time and make sure you make the best decisions for your specific situation.

I recommend you start with the Federal Housing Agency's (FHA) website and start educating yourself as much as you can. The next step would be to find a local non-profit agency near you that can help you learn even more. The FHA website can help with that.

https://www.hud.gov/topics/buying_a_home



Jennifer recommends the following next steps:

Look at the information at the FHA website: https://www.hud.gov/topics/buying_a_home
Find an FHA approved local non-profit housing organization that will work with you to help you get ready to purchase a home.

The his website is a good source to refer too but it can get overwhelming for some Shak Syed

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Rick’s Answer

Having good credit is important whether you plan to rent or buy, and can also impact getting a job, insurance, etc.
Here's a link to a great (short) video that explains credit, credit scores, and how to build good credit. Just ignore the 'ad' at the end pitching loans. https://www.youtube.com/watch?v=CPJmZ6AnCNY
Here are some additional info resources:
https://credit.org/courses/
americasaves.org

Hi Rick, this is helpful but doesn't directly answer the student's question. Can you share a little more about mortgages in particular? Gurpreet Lally

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Jonathan’s Answer

The mortgage is the debt on the property you purchase. The Note is the document that holds the terms of the loan such as the number of payments, interest rate, and payment amount. The note is tied to collateral, the property you purchase. Usually you will include with your monthly payment an amount to pay property taxes and homeowners insurance and if required mortgage insurance. Usually if you have a down payment t of 20% of the property value you will not be required to have mortgage insurance. Having mortgage insurance is not a bad thing, but if you can avoid it it would be to your advantage financially.


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