A Homebuyer's Guide to Mortgages

I. Understanding Mortgage Basics

For most Americans, mortgages are the primary financial tool that enables them to purchase a home. According to Redfin, an online real estate and brokerage company,  86.2 million Americans owned a home as of September 2024. Mortgages are an essential part of the homebuying experience for most people, yet they are a topic that the general public struggles to fully understand. 

In a study by MoneyWise, 1,116 Americans were surveyed on their knowledge of mortgages and buying a home; 56% failed the terminology quiz. This further affirms that many of us aren't very well-versed on the process, which poses a problem considering most people who want to purchase a home will need a mortgage to do so. Rest assured, if you fall into this category, don't fret - we're here to educate and build your confidence. 

Mortgages are typically long-term commitments, with 30-year terms the most common among homeowners. That said, understanding your options is crucial for making an informed financial decision of this magnitude. Armed with this knowledge, you'll be able to search for a home that matches your needs while landing on a financing solution that’s in line with your budget. 

In order to make the best decision for your finances and your future, it’s important to start with a basic understanding of mortgages. Familiarizing yourself with common terms and concepts is a great starting point for making the process feel less daunting! 

What is a Mortgage?

Let’s start by breaking down the basics of a mortgage in simple terms. A mortgage is a loan from a lender to cover the purchase of a home or other residential real estate. A mortgage allows you to purchase a house with a down payment, so you don’t have to pay the full price right away. As the borrower, the home or other real estate serves as collateral for the loan balance. Most lenders offer terms ranging from 10 to 30 years. The loan amount and type determine the required down payment, the monthly payment, and other fees.

A traditional mortgage payment consists of both principal and interest costs, and sometimes private mortgage insurance (PMI). Buyers are responsible for the down payment. For a conventional mortgage, the standard down payment typically ranges from 10 to 20% of the sale price. This means that if the home price is $250,000, the down payment would be $25,000.  However, it's important to know that different lenders have different requirements for other mortgage loans. At Education First, our conventional mortgages require only a 5% down payment.* This allows buyers to get into a home sooner than if they had to save for a 10% down payment and also allows buyers to hang on to more of their cash for future home expenses. 

Key Terms to Know

When you’re stepping into the housing market, it can be intimidating to engage in conversations about homebuying if you don’t have a strong understanding of the terminology. To boost your confidence, it can help to review some common terms surrounding mortgages and buying a home:

• Amortization: The process of gradually spreading out loan payments over a period of time. 
• Appraisal: An evaluation of the property's value, conducted by a professional home appraiser.
• Closing Costs: Fees and expenses, other than the purchase price, paid at the closing of a Mortgage loan. These typically include expenses beyond your down payment, such as a survey, title insurance policy, and recording fees. 
• Down Payment: An upfront payment made by the buyer to the lender. A down payment is usually a percentage of the property's purchase price.
• Equity: The difference between the market value of a property and the amount owed on the mortgage loan.
• Escrow: A financial arrangement where a third party holds funds or property until specific conditions are met.
• Interest Rate: The percentage charged on a loan, reflecting the cost of borrowing.
• Loan-to-Value Ratio (LTV): A ratio that compares the loan amount to the appraised value of the property.
• Private Mortgage Insurance (PMI): Insurance that protects the lender in case the borrower defaults on the loan. Most conventional loans require this until the buyer has achieved 20% equity in their home.
• Principal: The original sum of money borrowed in a loan, or the remaining balance of the loan, excluding interest.
• Refinance: The process of replacing an existing mortgage with a new one. Homeowners typically refinance when they can save money by securing a lower rate or a more favorable term. 

Now that you have a greater understanding of the standard terms encountered when researching mortgage loans, you can begin exploring the more complex aspects of real estate purchases.

Types of Mortgages

When it comes to understanding mortgage rates, it’s important to note the common rate options available on mortgage loans. 

In addition to these options, there are three major categories of mortgages to consider when considering the purchase of a home.

Conventional

Conventional mortgage loans are home loans offered by private lenders such as banks, credit unions, and mortgage companies. This type of mortgage is popular among borrowers with good credit and a strong financial history, because they can take advantage of competitive interest rates and terms. Conventional loans typically require a down payment of 3% to 20% of the home's purchase price. Borrowers who can put down at least 20% can avoid private mortgage insurance (PMI), which lowers their monthly payment.

There are two main types of conventional mortgages: conforming and non-conforming. Conforming loans adhere to the guidelines set by Fannie Mae and Freddie Mac,  including loan amount limits that vary by location. Non-conforming loans, also called jumbo loans, exceed these limits and may have stricter credit requirements and higher interest rates.

FHA

Designed to help more people become homeowners, FHA mortgage loans are a type of government-backed home loan. They’re insured by the Federal Housing Administration, protecting lenders against losses if borrowers default. This insurance allows lenders to offer loans with lower down payments and more flexible credit requirements, making them accessible to first-time homebuyers and those with less-than-perfect credit.

It’s important to note that FHA loans do come with some additional costs. Borrowers must pay an upfront mortgage insurance premium (MIP) at closing, as well as an annual MIP that is divided into monthly payments. These insurance premiums protect the lender but add to the overall cost of the loan. However, FHA loans remain a popular choice for many homebuyers due to their accessibility.

VA

VA mortgages are home loans backed by the U.S. Department of Veterans Affairs (VA). VA mortgages help veterans, active-duty service members, and eligible surviving spouses become homeowners. One of the biggest advantages of VA loans is that they often require no down payment, making it easier for those who have served to purchase a home without needing to save a large amount upfront.

To qualify for a VA mortgage, applicants must meet certain service requirements, such as a minimum period of active duty. They also need to obtain a Certificate of Eligibility (COE) from the VA. While the VA guarantees a portion of the loan, the loans are actually provided by private lenders, such as banks and mortgage companies. This means that while the VA has certain guidelines, lenders may have their own requirements for credit scores and income.

II. Navigating Homeownership

By building your knowledge of mortgages, you’ll be better equipped to begin your hunt for the perfect home. Applying the information will be key to securing the best deal for your financial future. For example, even a small difference in interest rates can lead to substantial savings or expenses over the life of the mortgage. When you have a strong grasp on how mortgage rates work and how they are influenced by market conditions, you’re more likely to lock in a favorable rate.

The road to homeownership won’t look the same for everyone, but there are some key guidelines you can follow to ensure you’re on the right path. With a clear picture of what you can afford, you have the ability to create a more comfortable living situation for yourself and avoid getting in over your head with payments that are too high. 

So, how can you get started? First, you’ll need to reflect on your current finances and create a realistic budget. Remember to consider the total cost of homeownership, including property taxes, insurance, and maintenance. These expenses can add up quickly and should be accounted for in the total cost of a home. 

Assessing Your Financial Situation

To be sure you’re making a sound investment, you'll need a clear picture of your financial health. This involves reviewing your income, expenses, savings, and debts. By doing so, you can establish an affordable price range for your new home. 

Credit Score

A good credit score is essential when seeking a mortgage for a new home because it directly affects your loan eligibility and interest rates. It essentially serves as an indicator of your reliability as a borrower. A higher score shows lenders that you pose less of a risk, leading them to offer lower interest rates and better loan terms. This can save you a significant amount of money over the life of your mortgage.

There are several factors that impact your credit score, including your payment history, credit utilization, length of credit history, new credit accounts, and types of credit used. Late payments, high credit card balances, and numerous recent credit inquiries can negatively affect your score. Keep in mind, opening new credit during the homebuying process can lower your credit score and increase your debt, which may jeopardize your mortgage approval. Always remember, consistently paying bills on time, keeping credit card balances low, and maintaining a long credit history can raise your score.

To improve your credit score, start by checking your credit report for issues and disputing any errors.  Make it a priority to pay your bills on time. Setting up automatic payments can help ensure you never miss a due date, which is key to maintaining a strong credit history. Avoid opening new credit accounts unless necessary, and try to keep old accounts open to maintain a longer credit history. These steps can help raise your score, making you a more attractive mortgage candidate.

Debt-to-Income Ratio

Your debt-to-income (DTI) ratio is a critical factor to lenders when they’re evaluating your application. It measures your monthly debt payments against your gross monthly income, helping determine your ability to manage the additional debt that a mortgage will bring. A lower DTI ratio shows that you have a good balance between debt and income, making you a trustworthy borrower.

Lenders tend to prefer a DTI ratio of 36% or lower, though some may accept higher ratios depending on other factors. To calculate your DTI, add up all your monthly debt payments, including credit cards, car loans, and student loans, then divide by your gross monthly income. 

To improve your DTI ratio, the idea is to lower your debt. To accomplish this, you should plan to pay down high-interest debts or consolidate loans to lower monthly payments. Then, avoid taking on new debt before applying for a mortgage. This not only enhances your mortgage prospects but also contributes to your overall financial health. 

Making a Purchase

If you’ve completed your financial checkup and feel that you’re ready to move forward with buying a home, it can be both exciting and overwhelming. This is especially true if you're a first-time homebuyer. To prepare for your homebuying journey, here are the typical considerations to keep in mind. 

• Saving for a Down Payment: A common mistake is overlooking how much you need to save toward the down payment. First, determine how much you need by researching typical down payment requirements for the type of loan you intend to pursue. Set up a dedicated savings account to keep your funds separate and organized. Be sure to create a budget that allocates a portion of your income toward this goal, so that you're consistently contributing to your savings.

• Getting a Mortgage Pre-Approval: Gather all necessary financial documents, such as income statements and tax returns, to streamline the pre-approval process. Most realtors will want this before they start showing your houses to make sure that what you are looking at is actually something that you can afford. The Education First FCU Mortgage team can help you get pre-approved quickly.

• House Hunting: At this point, you'll want to define your wants and needs in relation to your budget. This will help you narrow your search and prevent you from falling in love with a home you ultimately can't afford. Working with a real estate agent who understands your preferences and will help you explore listings that meet your criteria. Now is the time to attend open houses and schedule home tours to get a feel for the properties and neighborhoods. We recommend reputable sites like Realtor.com and Zillow.com as you hunt for the perfect home.

• Making an Offer: With an agent's guidance, decide on a competitive offer price based on market conditions and the home's value. Submit the offer through your realtor and be prepared for negotiations, as sellers may counter with different terms. Once an agreement is reached, you will sign a purchase agreement to move forward with the purchase.
  
  
• Home Inspection and Appraisal:  Plan to hire a professional inspector to evaluate the home's condition and identify any potential issues that could result in unexpected and/or costly repairs. An appraisal will also be completed to determine the property's market value, ensuring it aligns with the purchase price. 
  
  
• Closing Process: After your offer is accepted and you've completed the home inspection and appraisal, you'll move toward closing, a process that typically takes 30 to 45 days from initial disclosures. This stage includes a final walkthrough to ensure the property is in the agreed-upon condition, reviewing and signing numerous documents, and paying your closing costs, which usually is between 2% to 6% of the home's purchase price. Sometimes, the closing process can take some time, as it includes final steps such as property title search, property survey, and final signatures on all binding documents. Rest assured though, as long as you are working with a knowledgeable realtor and lending partner, your closing process will have minimal stress. 

Keep in mind that the home buying process is not one-size-fits all. While some homebuyers may find precisely what they are looking for early in their search, others may have to look for several weeks or even months to find a home that is the right fit for them and their budget. 

Exploring Mortgage Refinancing

With time, you may find that your mortgage needs as a homeowner have changed. Refinancing is a financial strategy that involves replacing your existing mortgage with a new one, usually to secure a better rate or term. There are a few notable situations where homeowners may benefit from refinancing their mortgage: 

• Lower Interest Rates: If current market rates are lower than your original mortgage rate, refinancing can reduce your monthly payments and overall interest paid.
• Shorter Loan Term: Refinancing to a shorter term can help you pay off your mortgage faster and save on interest over time.
• Switch Loan Type: Moving from an adjustable-rate mortgage to a fixed-rate mortgage can provide stability in your monthly payments.
• Access Home Equity: Refinancing can help you tap into your home equity to cover major expenses, such as home improvements or debt consolidation.
• Remove Private Mortgage Insurance (PMI): If your home value has increased, refinancing might eliminate the need for PMI, thus reducing your monthly costs.
• Improved Financial Situation: If your credit score has improved, refinancing could qualify you for better loan terms and lower interest rates.

III. Starting The Mortgage Application Process

As we mentioned earlier, understanding your financial situation will be key to beginning the mortgage application process. Next up is getting organized and gathering the necessary documents. These typically include proof of income, tax returns, bank statements, and a form of identification. 

It's also helpful to determine how much you can afford to borrow in advance. To do this, consider your current financial obligations and how a mortgage payment will fit into your budget. Using a mortgage payment calculator can be a helpful tool in estimating your monthly payments, allowing you to play with different loan amounts, rates and terms to see how they affect your plan. This planning will give you a better understanding of what you can afford and help you avoid overextending yourself.

With these details in place, you’re ready to take the next step and begin the Mortgage lending process. 

Getting Pre-Approved

Getting pre-approved not only gives you a better idea of what you can afford but also shows the seller that you're taking this process seriously.  There are many options when it comes to Mortgage lenders you can get pre-approved with, but there are specific perks to working with a credit union Mortgage lender. One major advantage includes local, in-house lending. This means your home loan is originated with Education First FCU and will not be sold to another lender or servicer. Larger Mortgage lenders tend to sell the Home Loans they finance, potentially causing more issues for you in the future because you may have to deal with multiple lenders throughout the life of your loan. With a credit union, this is not the case. The loan is held with the credit union for the entire life of the loan, allowing you the ease of working with one lender. 

Begin the Home Shopping Process  

Once you are pre-approved, it's time to start looking for a home! Now that you have determined a good estimate of what you can afford and have an official pre-approval, you can begin viewing properties with a realtor.

When choosing which home to buy, consider things like "What city do I want to move to?" "Does the school district impact my decision?" "Do I want to live in an urban area, or in a more rural neighborhood?" Your realtor will be your best friend throughout this process, as they can talk you through all your questions and help you identify the best homes for you to tour.  

In addition to your realtor, other sites that help determine the best area to live in include credible sites like DataUSA.io,   or Niche, which share valuable information, such as a city's population, economic data, average cost of living, and growth rate. Recent trends have also pointed to Facebook neighborhood groups as an increasingly popular resource for evaluating potential neighborhoods.  

Finalizing the Details

Once you get pre-approved, determine the neighborhood and home you want to buy. Now is the time to submit a formal application for a mortgage with your lender! Start by reviewing the loan estimate they’ve provided - this should outline the terms of your loan, with the interest rate, monthly payment, and closing costs. Make sure everything matches what you discussed and lines up with your expectations.

Upon final agreement with your lender, realtor, and seller,  you’re on your way to closing on your new home. There will still be a lot of paperwork heading your way, so take the time to read everything in detail and ask questions. Your lender or a closing agent can guide you through the closing process, explaining each document and answering any questions you may have. Upon finalizng all details and documents, you will officially be a new homeowner! Congratulations on this very exciting journey!