Angie's LIST Guide to
Mortgage loans

Taking on a mortgage loan is a massive responsibility almost always an essential part of purchasing a home. Not only is it a huge expense, a mortgage loan also a complicated set of concepts, options and obligations. Navigate the turbulent waters of mortgage loans by learning fundamentals behind the loan and paying it off.


First-time home buyers may be surprised at how little of their payments goes to principal in the early years of a mortgage.
First-time home buyers may be surprised at how little of their payments goes to principal in the early years of a mortgage.
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The basic concepts

Buying a home is still the one of the most reasonable financial investments for American families. The global financial crisis, the subprime mortgage meltdown and the credit crunch may have left real estate investors on Wall Street high and dry, but for average Americans the dream of home ownership is not so much a matter of realizing huge profits, but rather a sensible investment that can bring peace of mind to their families.

The process of purchasing a new home will invariably involve applying for a mortgage loan. While it's possible to buy a house with cash, current real estate prices put cash purchases essentially out of reach for most home buyers. Considering that the median home price in the United States floated around $160,000 at the end of 2011, a mortgage loan is still the preferred method to home acquisition.

The mortgage lending industry has undergone comprehensive reform since the heady days of subprime lending before 2008. Credit and underwriting guidelines have become stricter than ever and there is an emphasis on financial education. The following information should be read as a guide for house shoppers who will more than likely choose a mortgage as the path to home ownership.

Affordability should be the foremost aspect of any mortgage application process. This is determined by the buyer's income, the amount of cash that can be set aside as a down payment, their current debt obligations, the potential expenses required to maintain the household and the amount of the monthly mortgage payment due to the lender each month. To calculate a mortgage payment, applicants must also understand the current financial terms in the market. Typical terms include:

  • Interest rate
  • The term of the loan, also known as the life of the loan
  • The down payment
  • The housing expense to income ratio

Home affordability can be determined by a mortgage broker or bank loan officer during the prequalification process. A mortgage professional can calculate how much home can be afforded by analyzing the applicant’s income, debts and assets. While real estate agents used to perform prequalifications in the past, now the preference is for the process to be performed by mortgage loan professionals.

After the prequalification is taken care of, the preapproval process comes next. A borrower's credit worthiness and their ability to repay the loan are considered in this step. This is when preliminary loan amounts and the possible amount of monthly payments are communicated to the applicants. Most preapprovals will not include the type of mortgage loan or how much it will cost to the borrower to obtain the loan.

Interest rates and down payments

Once a preapproval has been issued, the applicant is given a set of conditions that must be met prior to approval. In the meantime, the type of mortgage product, the interest rate, points and closing fees are calculated and, in some cases, negotiated.

The two main types of mortgage products that applicants will be presented with are fixed rate and adjustable rate loans. Potential borrowers who prefer stable payments and expect to stay in their homes for more than 7 years will be better served by a fixed interest rate, while borrowers who would like to start off with lower payments –with the understanding that future payments may increase- are suitable for borrowers who don’t expect to stay in their new home for too long.

The interest rate of most fixed rate mortgage products is calculated by the process of amortization. This means that although the amount of the principal portion and interest due rise and fall during the life of the loan, the monthly payments remain the same. For adjustable rate mortgages, the initial rate of interest is fixed according to a period of time that is agreed upon prior to closing. After the initial phase of the loan, the interest rate will more than likely rise –although in some cases it may actually decrease.

The typical mortgage amount financed these days includes all origination and closing fees, as well as points or commission charged by the lender and broker.

Questions to ask

The power in the mortgage lending industry has mostly shifted to the banks. Mortgage brokers are still plying their trade but new licensing and compliance requirements have greatly reduced their ranks. Whether a home shopper applies for a mortgage at a major bank through a loan officer, or with a mortgage broker, it is important that borrowers find an individual who will help them through the process from a financial planning point of view.

To ensure that reliable mortgage professionals are chosen, borrowers should feel free to ask the following questions:

  • What is the best mortgage product for me?
  • How much of a down payment do I need to have at closing?
  • How much am I going to have to pay for points?
  • What personal debts, such as credit cards, should I pay down before closing?
  • How much will I pay for title insurance? What about flood and homeowners insurance?
  • Is it better to pay for insurance and property taxes each month in escrow, or should I take care of that on my own?
Benefits of making additional payments

Another good question to ask mortgage professionals is whether they think it is a sensible idea to adopt a biweekly mortgage payment plan in order to accelerate loan payment. With a biweekly mortgage plan, borrowers pay every two weeks. The 26 payments schedule is equivalent to paying out 13 months of loan payments each year. Some mortgage loan agreements may not allow borrowers to do this, but it can make financial sense for those who can afford do it. Additionally, homeowners should make sure not to pay for this option, as it reduces the financial incentive and many loan providers offer an online option to increase the principal of each payment. If homeowners can calculate the additional cost themselves, increasing principal on existing payments can serve as a biweekly solution when a free one isn't available.

By making biweekly payments, you may potentially save significant amounts of money in interest over the life of a loan. However, with interest rates currently low, the option may be less appealing depending on your specific loan. Still, accelerating the repayment process by making a few extra payments towards the principal amount due is often an advantageous way to reduce the overall debt burden. The best way to accomplish this is to lay out a disciplined savings strategy. A mortgage professional should be able to easily calculate the cost savings benefit on a spreadsheet or loan calculator for interested borrowers.


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