Introduction

When most people buy a home, they need a purchase mortgage to secure the necessary funds. A mortgage is an agreement where a lender provides you a loan to cover the cost of buying the home, which you pay back on a predetermined schedule.

While it’s a straightforward concept, it’s important to understand the ins and outs of mortgages before you get one. For example, you need to know how to find the right lender, the different types of mortgages, what the closing costs are likely to be, and so much more.

If you don’t make informed and educated decisions when buying a home, you could end up with a poor rate, unfavorable terms, or subpar lender, among other issues.

This guide takes a closer look at what to know when taking out a purchase mortgage to ensure you find the right one for your needs.

Understanding Purchase Mortgages

A purchase mortgage is a loan that a bank or other lender gives you to buy a home. This, combined with a down payment, gives you the funds you need to complete the purchase. You pay back the loan with regular monthly payments for a set period. The exact amount you pay depends on the price of the home, your interest rate, and the loan term.

The loan is secured on the property—so if you fail to make repayments, the lender can take possession of your home. Keep in mind that only part of every repayment goes towards the principal, while the other goes to paying off the interest.

While a purchase mortgage is the most popular housing-related financing option, it’s not the only one. Other examples include mortgage refinancing, which involves renegotiating or revising your current mortgage agreement, often to get a better rate. You essentially replace your original mortgage with another one with more favorable terms.

Another option is a home equity loan—when you use the equity in your home (the difference between the balance of your mortgage and the home’s value) to borrow money, using the equity as collateral.

Types of Purchase Mortgages

There are several types of mortgages you can get when buying a home.

Fixed-rate mortgages

A fixed-rate mortgage keeps your rate the same for the entirety of your loan. These mortgages provide stability and make it easier to budget as you know your payment won’t change. They’re best for people with great credit who feel more comfortable with consistent mortgage payments rather than ones that change multiple times throughout the term.

Adjustable-rate mortgages

Conversely, adjustable-rate mortgages (ARMs) begin with a fixed introductory rate for a set period (generally about 5 years), but after that your rate changes over time (often about 1-2 times each year) based on the economy.

The benefits are that you get a low introductory rate (often lower than what fixed-rate mortgages provide) and could end up paying less over the years if rates fall. However, ARMs are also risky as interest rates could rise over time. It’s harder to budget if your mortgage payment changes frequently.

Government-backed mortgages

There are three types of government-backed mortgages: Federal Housing Administration (FHA) loans, Veterans Affairs (VA) loans, and US Department of Agriculture (USDA) loans. Each helps make home ownership more affordable and accessible, but they’re different in terms of eligibility and benefits.

• FHA loans are available to anyone. You’ll need a 3.5% down payment if your credit score is over 580, or a 10% down payment if it’s between 500 and 579. Many FHA lenders also require a debt-to-income (DTI) ratio of 43% or lower.
• VA loans are exclusive to veterans and current military members. They typically have lower rates than other mortgages and don’t require a down payment. Most VA lenders require a credit score of 620 or higher, and a DTI ration of 41% or lower.
• USDA loans are meant for low- or middle-income households buying a home in a rural area. Like VA loans, USDA loans have no down payment and have low interest rates. However, most USDA lenders require a 41% DTI ratio and a credit score of 640 or higher.

Conventional mortgages

Mortgages not backed by the government are referred to as “conventional.” They require a credit score of at least 620 and are harder to qualify for. Also, if you put down less than 20%, you’ll normally have to pay private mortgage insurance (PMI).

The Mortgage Application Process

Applying for a mortgage involves gathering a range of personal and financial information. It's a good idea to plan ahead so the process goes smoothly. Here are the steps to prepare for:

Pre-approval

Before you even start searching for a home, it’s smart to get pre-approved. This means that a lender/broker looks at your finances, debt, and credit, and determines how much you’re able to borrow based on your current situation.

Being pre-approved shows sellers your offers are serious and credible. It also enables you to find out your approximate price range for houses.

You’ll need to provide the lender with documentation such as

• Your ID/driver's license for personal information
• Social Security number
• Bank statements
• Information about your debts and assets
• Proof of income and employment information
• Tax returns

After reviewing your information in detail, the lender gives you a letter that outlines the purchase price you’ve been approved for, an estimated interest rate, and when the pre-approval expires.

Shopping for lenders

Once you’re pre-approved, you’ll begin looking for a property. When you have a home you’re interested in, the next step is to shop around for the right lender.

You should consider all types of lenders, including banks, credit unions, mortgage brokers, and online lenders. Reach out to several of them, comparing factors like interest rates, terms, down payment requirements, closing costs, and any other fees a company charges. Consider the lender’s reputation and customer service provision, too.

Submitting an application

Once you’ve found the right lender, it’s time to submit an application. The document asks you for much of the same personal, financial, and employment information you needed for pre-approval.

In addition, you’ll also need to offer details about

• The type of mortgage you’re applying for, and whether it’s joint or individual
• The home you’re purchasing, including the address, sale price, property size, etc
• How you’re planning to use the property (for example, as a primary residence or a 2nd home)

After you’ve applied, you’ll generally hear back from the lender within a couple of business days.

Key Factors to Consider

When evaluating different mortgage offers, there are several important aspects to be aware of to ensure you find the right one.

Interest rates

Your interest rate is arguably the most important thing to consider when getting a mortgage. The lower your interest rate, the cheaper your mortgage loan is in the long term. Something as small as a 1%-2% difference in your interest rate could mean tens of thousands of dollars saved over your term. This is because with a lower rate, more of your monthly payment goes to principal, instead of interest.

Interest rates are either fixed (the same throughout your entire mortgage) or adjustable (changing throughout your term based on market conditions and the economy).

Loan terms

A term is how long you have to repay a loan. Most mortgages have 15-, 20-, or 30-year terms. Your term has a significant impact on how much you end up paying for your mortgage.

Shorter terms have larger monthly payments but are generally cheaper in the long run as they have lower interest rates. On the other hand, longer-term mortgages have affordable monthly costs but are much more expensive overall thanks to larger interest rates.

Down payment

The down payment is the money you pay upfront when you buy a home. A larger down payment reduces how much you need to borrow with a mortgage. Each lender and loan type has different requirements, but a 20% down payment is standard for most conventional mortgages.

You can generally put less than 20% down, but most lenders require you to buy private mortgage insurance (PMI) if you do. This is a small charge that’s usually added to each monthly payment, costing between 0.5% and 2.5% of your mortgage loan amount every year.

Lenders charge this because giving out a mortgage with less than 20% down is riskier, and this insurance protects them if you default on the loan.

There are pros and cons associated with different down payment amounts. For example, if you put down 20%, you avoid PMI and don’t need to take out as large a mortgage. However, it takes some people years to save enough to put 20% down.

On the other hand, while a 10% down payment is easier to save for and lets you enter the world of home ownership quicker, it leads to a larger mortgage and having to pay PMI.

Closing costs

Closing costs are the upfront one-time fees you’ll need to pay when you buy a home. Some of the most common closing costs include home inspection, appraisal, legal, and notary fees. These costs normally equal 3%-5% of your total loan amount. It’s a good idea to use an online calculator to help you estimate your closing costs and prepare for paying them.

Credit Scores

You should also consider your credit when taking out a mortgage. People with a good credit score often get cheaper interest rates and more favorable terms. Conversely, if your credit history is subpar, you’ll need to pay a higher rate and will have fewer options. If your credit is poor, it may be worth delaying buying a home until it improves so you can get a more favorable rate.

Common Pitfalls to Avoid

Some of the most common mistakes to avoid making when taking out a mortgage include the following:

• Taking on more mortgage than you can afford: If your mortgage is more than you can afford, it could cripple you financially. When you can barely make mortgage payments every month, it hurts your ability to build an emergency fund, save for retirement, or spend on other expenses.
• Not shopping for the best rate: If you go with the first lender you reach out to, you could be leaving a better deal on the table. The more lenders you speak with, the better your chances of finding the best rate or terms.
• Overlooking hidden costs and fees: Many lenders charge hidden costs and fees, such as mortgage discharge fees or prepayment penalties. Ensure you read the fine print to be aware of all potential fees before signing anything.
• Ignoring the terms and conditions of the loan agreement: Each mortgage has a selection of terms and conditions, which include prepayment penalties, whether you can take your mortgage with you if you move to another home, your payment options, and more. You should study these carefully to avoid being hit with unexpected penalties or fees.

Conclusion

Knowing the ins and outs of purchase mortgages will ensure you end up with the right deal for your needs. This includes being aware of different mortgage types, how to apply for one, and the common mistakes to avoid—like taking out a larger mortgage than you can afford or ignoring hidden costs.

When evaluating different mortgages, it’s also important to consider the interest rate, loan terms, down payment, and closing costs. One way to identify the right mortgage option is to use a comparison site like mortgagelenderscompared.com, so don’t hesitate to use these resources to help you in your search.