Basic concept of a mortgage

Buying a home is still the one of the most reasonable financial investments for American families, and the process of purchasing a new home will invariably involve applying for a mortgage loan. The mortgage industry has undergone comprehensive reform in the past few years, and credit guidelines have become stricter. Throughout the industry, there is an emphasis on financial education. The following information should be read as a guide for house shoppers who will need a mortgage as their 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 used as a down payment

• His or her current debt obligations

• The potential expenses required to maintain the household

• The amount of the monthly mortgage payment due to the lender

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 you can afford by analyzing your income, debts and assets. While real estate agents used to perform prequalifications, the preference now is for the process to be performed by mortgage loan professionals.

After the prequalification is handled, the preapproval process comes next. A borrower's credit worthiness and 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 the borrower to obtain the loan.

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

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, 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 seven years will be better served by a fixed interest rate.

However, if you don't plan to stay in your home for too long, or would like to start off with lower payments — with the understanding that future payments may increase — adjustable rate loans could be more appropriate.

The interest rate of most fixed rate mortgage products is calculated by the process of amortization. This means that although the amounts of the principal portion and interest due rise and fall during the life of the loan, the monthly payment remains the same. For adjustable rate mortgages, the initial rate of interest is fixed according to a period of time agreed upon before closing. After the initial phase of the loan, the interest rate will most likely rise.

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 still ply 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 must I have at closing?

• How much will I 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 additional payments

Another good question to ask mortgage professionals is whether they think it makes sense to adopt a biweekly mortgage payment plan in order to accelerate the loan payment. With a biweekly mortgage plan, borrowers pay every two weeks. The 26-payment schedule is equivalent to paying out 13 months of loan payments each year. Some mortgage loan agreements may not allow this, but it can make financial sense for those who can afford do it (if your agreement permits it).

Make sure you're not paying an additional fee for this option, as it reduces the financial incentive. If there is a fee involved, review your online payment options. Many loan providers offer homeowners an option to increase the principal of each payment. If you can calculate the additional cost yourself, increasing principal on existing payments can serve as a biweekly solution when a free one isn't available.

By making biweekly payments, you can 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 toward the principal amount due is often a good 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 for you the cost savings benefit on a spreadsheet or loan calculator.

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