Frequently Asked Questions about Mortgages
Are you thinking about buying a new house or condo here in Northern Virginia? If so, you have likely given some thought as to what it means to apply for a mortgage loan in order to help pay for the up-front purchase cost of your new home. Below we’ll share answers to some of the most frequently asked questions about mortgages and explore how interest rates affect the amount that you’ll pay over time.
What is a Mortgage?
In simple terms, a mortgage is an agreement between a borrower (you, perhaps) and a lender (typically a bank or underwriter) to lend money which will be used to purchase a home or a property. The property is used to secure the loan, which means that if the borrower cannot pay the loan and the required amount of interest the property will then be owned by the lender – a process known as foreclosure.
There are a number of different parts to a mortgage loan. The down payment is the portion of the home’s purchase price that you’ll be required to pay up front, and is generally somewhere between 10 and 20 percent of the total. The principal amount of the loan is the remainder of the purchase price. You’ll be required to pay interest on the loan which is the fee that the lender charges you in order to receive their funds. Finally your mortgage will be amortized over a period of years, typically anywhere between 10 and 30, allowing you to pay it off in monthly installments.
What Affects the Interest Rate on My Mortgage Loan?
Whether you employ the services of a professional mortgage broker or you shop around to do your own research, you’ll quickly discover that interest rates are different between products and lenders. There are a whole host of factors that impact mortgage rates, some of which – such as your credit score – will be unique to your situation and others – such as the price of the 10-year Treasury bond – which have nothing to do with you.
It’s best to speak directly with a lender or broker to get an idea of how your unique situation will impact your interest rate. If you have good credit, have a reasonable down payment ready and are buying a regular single-unit house or condo with a typical mortgage you’ll generally receive a standard interest rate.
How Does an Interest Rate Affect How Much I Owe Each Month?
Even the smallest change in your interest rate can mean a difference of thousands of dollars over the term of your loan – especially if the changes happen early on in your repayment period. When you take out a mortgage, you begin by paying a high amount of interest that decreases over time as you pay down the principal amount.
For example, if you have $200,000 mortgage at a 5 percent interest rate in the first year you would owe $10,000 in interest. If you were making $1,000 per month in payments you would only end up paying $2,000 against your principal, reducing it to $198,000. The next year your required amount of interest would be lower so by paying the same amount in monthly payments you will reduce your principal amount further.
However, let’s say your interest rate rose from 5 percent to 5.5 percent when you still had $175,000 remaining on your loan. Instead of owning $8,750 in interest that year, you would owe $9,625. This small half-percent rise in your interest rate ends up increasing your costs almost $1,000 in that single year alone.
As you can see, small changes in your interest rate can affect your monthly payments significantly. The good news is that if your interest rate goes down, you will see your costs reduced accordingly.
What is the Difference Between a Fixed Rate and Adjustable Rate Mortgage?
A fixed rate mortgage is one in which your interest rate remains constant, thus preventing the scenario described above. If you have a fixed rate mortgage at 5 percent and suddenly interest rates rise to 6 percent, nothing changes. You’ll still owe the same amount and make the same payments as you were before.
In an adjustable rate mortgage, your mortgage rate fluctuates based on changes in the market. This can be a benefit if interest rates fall during your repayment period as you’ll end up paying less in interest which can free up cash for you to use in other ways. Of course, as demonstrated above the reverse can also be true; if rates rise, you can end up paying more in interest.
Note that while adjustable rate mortgages tend to start out with lower rates or payments in the early part of the loan they can become much higher later. If you prefer stability for your budgeting purposes it may be best to stick with a fixed rate mortgage.
How Much Money Can I Get?
When determining how much to lend you, your bank or underwriter will take a number of factors in to consideration. Your credit score will play a role as the lender needs to have a reasonable guarantee that you’ll be able to pay back the loan. They’ll look at your ‘debt to income ratio’ which is essentially what is left from your total monthly income after you pay credit card, student loan and other debts. They’ll also investigate the value of the home that you are purchasing, and will usually ask that you have a professional appraisal done of the property to be sure that it’s worth at least as much as you’re paying for it.
While there is a bit of a process involved, applying for a mortgage ensures that you’ll be able to purchase your home with the convenience of affordable monthly payments spread out over a reasonable period of time. If you have any questions about mortgages that we haven’t addressed above or if you would like to discuss buying a home in the Northern Virginia area, contact The E4Realty Group today at 703.722.5018 or by email below and we’ll be happy to help.