Demystifying Mortgages For The First Time Home Buyer

Buying a home can be an exciting and a stressful time. If this is your first time buying a home, be prepared for a deluge of information, advice and opinions. And don’t let your real estate agent or your banker make the most important decision of them all – your mortgage. You know your financial situation better than anyone else and you are best equipped to make an informed decision.

But understanding a mortgage loan isn’t as simple as say, an auto loan. There are multiple variables to consider and the language used to pitch the loan is quite different. Educating yourself is a good start! Getting familiar with the entire mortgage process at a high level is extremely important.

Rather than throw around definitions, I’m going to try a different approach.

The following snippets are taken from actual loan ads by mortgage lenders

This will give you an idea as to what to look for when shopping for a mortgage. With the knowledge gleaned here, you should be able to decipher any loan application!

Fixed Rate Mortgages

What is a Fixed Rate Mortgage?

What is a Fixed Rate Mortgage?

Fixed Rate Mortgages are very popular since this offers the least amount of surprises when it comes to making monthly payments! Here’s how Fixed Rate Mortgages work.

There are two important variables to consider when it comes to choosing a Fixed Rate Mortgage: The rate and the duration of the loan.

Rate

The rate is the interest at which the lender lends you the money and the duration is the term of the loan. You will not get the advertised rate unless your credit score is excellent. Rates vary from lender to lender, so shop around!

Term

Typical durations for Fixed Rate Mortgages are 15, 20 and 30 years. The shorter the duration, the lower your interest rate will be but higher your monthly payments. The trade-off is between how much can you afford as monthly payments versus how much you will be paying overall to own the house.

Rate Buy Down

Also referred to as buying discount points, is an option to lower your rate by prepaying the interest at the time of borrowing. For example, if the lender offers a loan at 4.75% and you wish to lower it to 4.00%, most lenders will agree to lower the rate by offering discount points. 1 point is 1% or your loan amount.

Escrow Waiver Fee

An Escrow is an account setup by your mortgage company on your behalf to pay for property taxes and home owners insurance. The mortgage company collects this money at the beginning of each year and makes the payments on your behalf when taxes or insurance premiums are due.

If you wish to do this yourself and keep the interest which you would otherwise lose out if put in escrow, some lenders will charge a fee for it. This is the Escrow Waiver Free. In the ad above, the lender Alliant Credit Union is highlighting the fact that they do not charge this fee.

Origination Fee

This is the fee charged by your lender for processing your loan. Origination fee can be a fixed charge or a percentage of your loan amount. For example, PenFed mortgages have a 1% origination charge whereas Alliant Credit Union charges a flat $1,350 origination fee on a 30 year fixed mortgage. So if your loan amount is for $200,000, a PenFed loan will cost your $2,000 as opposed to $1,350 with Alliant.

Rate Lock-in

Loan rates change frequently and are determined by the current market conditions. Loan rates are set by a number of factors, most importantly the Prime Rate set by the Feds.

Lenders offer the option of ‘locking-in’ a rate for a certain number of days. Usually, 45, 60 or 90 days. If the deal closes within the lock-in period, you are guaranteed the lock-in rate. If, at the time of closing, the rate is lower than your lock-in rate, you are still bound by the lock-in rate.

If you choose to float your rate, your rate will be determined by the rate at the time of closing.

The more time a lender offers as a lock-in period, the better.

Adjustable Rate Mortgages (ARM)

What is an adjustable rate mortgage? (ARM)

What is an adjustable rate mortgage? (ARM)

As the name indicates, with an ARM, the rate fluctuates after an initial teaser rate.

From the above, 5/1 ARM indicates a fixed rate for the first five years and a varying rate every year after that. ARMs are a good choice if you plan on owning the house for a short period of time.

Conforming Loan

Conforming or conventional loan means that the loan is eligible for purchase by federal housing agencies, Fannie Mae and Freddie Mac and that the loan value is within the set limits. Conforming loans cannot be more than $417,000 for a single unit home.

Points

See discount points above.

Rate & APR

If you look at the example above, you’ll find two values for the interest rate and that the APR is slightly higher than the rate. What is the difference between these two? Which value should a home buyer be looking at?

Say you locked in a rate of 4% but had to pay $2,000 as origination fee, purchased points, prepaid interest and other fees. What is your actual rate in this case?

The actual rate would be much higher than what you thought you were getting. Thankfully, the Truth in Lending act mandates lenders must disclose the rate as APR which takes into account all such fees. Good example of regulation done right no matter what the loonies say.

Jumbo Loans

What is a Jumbo loan?

What is a Jumbo loan?

Jumbo loans, also called non-conforming loans are loans which cannot be repurchased by Freddie Mac and Fannie Mae in full. This makes it harder to sell the mortgage by the lender, hence, the rates will be higher considering the higher risk.

With a few exceptions depending upon the state, if the loan amount is over $417,000, it is considered a Jumbo loan.

Mortgage Refinancing

What is Mortgage Refinancing?

What is Mortgage Refinancing?

If you are an existing home owner paying high premiums due to your loan lock-in rate, there are options to reduce your interest rate. Especially now, when the interest rates are at a record low.

When you refinance a mortgage, you essentially sell the mortgage to the new lender and start paying premiums at the new rate going forward. The catch is, you have to go through another closing and the costs associated with it. And closing costs are quite significant.

No Cost Refinancing

Some lenders offer what’s called a low or no cost refinance option. Cost here refers to Closing costs.

With a no cost loan, you don’t pay for closing costs at the time of refinancing your mortgage. But instead, this is rolled into your loan as a part of the principal. Or the lender might charge a higher interest rate to cover this cost.

Always be sure to ask what is covered if you decide to choose this option.

My Thoughts

The American dream isn’t complete till you own a home! No one likes a depressed economy, but with it comes low interest rates. This is as good a time as any to buy or refinance a home. Just don’t go overboard! Evaluate your financial situation, cover the basics, educate yourself and make a decision.

45 thoughts on “Demystifying Mortgages For The First Time Home Buyer

  1. Very informative. I like the line “Good example of regulation done right no matter what the loonies say.” In complex financial transactions, transparency is a positive – for both buyer and seller. Granted there is a cost to clearly spell out the terms but sellers are benefitted. CountryWide would be in business today if they hadn’t been so devious. Something for businesses to think about when they try to hide fees and take advantage of customers.

    • Exactly! I’m glad a number of changes were brought about by recent laws which benefit the consumer.

      I have no sympathy for Countrywide/BofA.

  2. Transparency is always a good thing, especially in financial transactions, and especially for the person receiving the loan. It is amazing how many people sign documents and agree to terms they don’t understand in transactions for hundred of thousands of dollars. The first home I bought we got an ARM, but that was at a time when interest were much higher and falling. I wouldn’t touch an ARM today. With interest rates this low, lock in a fixed rate loan. You’ll be glad you did 10 or 15 years from now.

    • ARMs are good only if you know for sure you won’t be in the house for a long time.

      I’m personally squeamish with ARMs. Reminds me of Comcast offers where the fist month is $1 and you pay steep monthlies every month after that! Do people really fall for this?

  3. Good explanation! You provide a good framework for comparing mortgage refinancing costs and differences.

  4. There are so many options with mortgages! It can get confusing, but it’s worth it to set up an excel spreadsheet and really try to understand what your monthly payments over the whole life of the loan will be when trying to decide.

  5. Very resourceful post Moneycone! I like those screenshots. Diving into the property market can definitely intimidate first time homebuyers. Taking the time to research the market, get a good agent, and an affordable loan is so important. -Sydney

  6. I’m still bitter over the absurdly priced “title search” every time I buy or refi a home. It’s like $3500 each time for some basic paperwork check that’s probably an hour’s work. It’s like an industry scam; I can’t imagine their cost is anywhere near that.

  7. Nice article MC :) Very informative and breaking down the topics not to confuse the reader. ARMs are what killed many people during the housing bubble… as it became hard to unload their properties. Great tips. Thanks for sharing :)

  8. Thanks for the thorough explanation. Even though I live in Canada and not all of these options apply there is still some good general knowledge that I can take home. It can be a really complex and confusing process so information like this is really helpful.

  9. Great guide! I’ve never been quite sure what some of these terms meant, but it’s crystal clear now! I think the next challenge would be figuring out what rates and terms to choose once the time comes for me.

    • Home buying can be confusing and stressful. Totally relying on your agent isn’t very prudent.

      Glad you liked the post Jeffrey!

  10. I used to work in a bank and worked on a handful of mortgages, but it is a lot different on the other side of the table. I am closing my first home purchase next week!

    This is a great explanation of many of the confusing terms and conditions many lenders place in their loans.

  11. Great article MC!

    Although I’m not in the market for a home now, as I really value my freedom and flexibility right now, this is a very informative article with plenty of great information! You really quarterbacked this thing. Good stuff.

  12. You have created an outstanding resource here MC. I like your succinct descriptions. Your call to action is a fitting conclusion too. My last corporate job was as a loan officer in a large mortgage company. I really enjoyed talking people through their options, and helping them make the best choice.

    • You were a loan officer? You should definitely write about your experience! Your insights could be very valuable to potential home buyers.

  13. I didn’t know some of the terms. I am not a home buyer yet, I think the back to basics approach in this article will help me.

  14. I am always angry when I think about how people get charged to waive escow, what a scam.

    I am contemplating refinancing right now. We only have about 6 years left on the mortgage but rates are so low. I never thought I would consider refinancing the 4.75 percent rate I have now, these rates are crazy low!

    Another great, informative post MC!

  15. I wish I had this post when we were buying our first home. Thank you for such a great post MC.

  16. As usual, a great read. Interesting enough, it supplements my recent post about the power of passive income through real estate investing, which also links to my “how to buy an investment property” post. I believe the latter post covers your last statement of “don’t go overboard!”

    I’ll be sure to link this post as a reference.

  17. Great job on the mortgage definitions! By the way, have you seen rates lately? Crazy!

  18. Excellent list and explanations. Locking in a good rate is important even for those who are refinancing.

  19. MC, How To extraordinaire does it again! Just curious, how did they select $417,000 as the magic number for loans being conforming or jumbo? Nice job!

  20. Excellent list and explanation MC. I am learning as much as I can about first time home buying as we are planning to buy in the next year or two. It is confusing with so many terms and so many small expenses. Thanks for this primer!

  21. On no cost refinancing, I am glad you explained what that is as there’s no free lunch out there. The term can be misleading ;)

    Great article as it covers the subject fully!

  22. This is GREAT. I am not looking to buy for several more years, but it’s never too early to get informed, right?

  23. Very nicely written, MC. Would that all perspective home buyers get well educated on the mechanics of home mortgages, before taking the plunge.

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