What Is A Mortgage: A Comprehensive Guide To Home Loans
Sam Hawrylack27-Minute Read
July 08, 2022
Buying a house means more than finding your dream home and making an offer. You’ll likely need mortgage financing to buy your home, which means you have a lot of decisions to make.
Fortunately, there are many loan options for first-time and repeat home buyers, each with different requirements, terms and costs.
Read our comprehensive guide to home loans to learn everything you must know to be an educated borrower.
What Is A Mortgage?
A mortgage is a loan used to buy real estate. Although you might hear it called a home loan or mortgage loan, they all fall under the same mortgage definition. When you take out a mortgage, you transfer the security interest in the home to the lender funding the loan. The security interest is the loan’s collateral. Lenders use it as leverage to offset the risk of lending you such a large amount of money. For example, if you stop making your payments, the lender can foreclose on the property, selling it to make back what they lost when you defaulted.
Why Do Home Buyers Need Mortgages?
Most Americans dream of homeownership but don’t have enough cash to pay for a home upfront. The mortgage industry was constructed to help more people buy homes rather than just those with enough cash to pay for it in full. Borrowers could leverage their investment by investing some of their own money in a home while borrowing the rest.
The mortgage industry is overseen by the federal government, which ensures the industry remains liquid. This is how lenders can continue to fund future loans, and the housing industry can continue fueling the U.S. economy. The industry itself makes up 15% – 18% of the gross domestic product (GDP), which is an important indicator of our nation’s economic output according to the National Association of Home Builders (NAHB).
How Does A Mortgage Work?
Home loans at first might seem overwhelming, but if you look at the big picture, you’re borrowing money to buy a home. You pay interest on the loan while you have a balance, which is the profit the lender earns for lending you money to buy a home.
Think of it like buying a car. You borrow money to buy the car, and the vehicle is the collateral. If you don’t make your payments, you could lose your car. The only difference with a mortgage is that the purchase price of a home is usually much higher than a vehicle, as is the monthly payment.
Mortgage Amortization: The Difference Between Renting And Owning
Many first-time home buyers balk at the idea of having a mortgage payment, especially when the mortgage payment is the same as their rent. They figure, why bother buying and paying all those costs when they could just rent?
While you pay mostly interest on your mortgage payments when you first take out a mortgage, you also chip away at the balance. As time goes on and you begin paying more and more of the principal balance, you start building home equity. This is the main benefit of owning vs. renting. You start owning more of the asset, which is the return on your investment.
Also, as a homeowner, you can benefit from a higher value of the home through appreciation. Homes typically appreciate over time; yours may appreciate even faster if you make improvements. The combination of regular mortgage payments and home appreciation can help you earn a decent return on your investment. When you rent, you have nothing when you terminate your lease except your belongings.
It’s normal to feel somewhat intimidated about taking out a mortgage. Rest assured that Rocket Homes Real Estate LLC is dedicated to reducing the stress of buying a home by educating you as much as possible. Understanding your options and financial responsibilities makes you an empowered buyer.
Your obligations as a borrower are found in your mortgage terms, which include such information as the total amount borrowed, your interest rate, the type of loan you have, how long you have to repay the loan and the penalties for missing a mortgage payment. Mortgage terms are different for every home buyer and will depend on several factors including credit score, down payment, type of loan and amount borrowed. That’s why it’s always best to ask as many questions as possible to understand your specific loan terms.
The Cost Of Your Mortgage: How Are Interest Rates Determined?
Interest rates are a hot topic for borrowers. Everyone wants the lowest rate and wants to know how rates are determined.
There are many moving pieces involved in what affects interest rates, but overall, the economy's pressure drives them. Usually, when the economy needs stimulus, interest rates fall to spur more growth. But when the economy booms or inflation needs to cool down, interest rates increase to reduce demand.
There are three major players in your interest rates: the Fed, the state of the lending market, and your financial risk factors.
The Federal Reserve (the Fed) is the central bank of the U.S. They don’t directly set mortgage rates, but they do set the federal funds rate. This is the interest rate charged to banks and other lending institutions when they borrow from one another. Thus, the federal funds rate has a trickle-down effect on the interest rates lenders charge to borrowers to make a profit.
The Lending Market
Most lenders originate mortgages and then sell them to one of several major investors as part of a mortgage-backed security. This allows them to make money off the loan in relatively short order and get funds to make more loans without having to wait up to 30 years to see the full return. Still, some lenders keep mortgages on their books. These are portfolio lenders.
Remember that lending is a business. Lenders typically set their own prime rate based on the federal funds rate and then mark it up so they can take on the risks that come with lending money and also make a profit.
Not many borrowers will see the prime rate. It’s reserved for loans that carry the least amount of risk. Other loans, including long-term, uncollateralized and residential, are usually priced higher. It’s also important to note that because of the collateral home loans offer, lenders offer mortgage clients lower rates than other loans such as personal loans and credit cards, which don’t have collateral so they’re considered riskier.
Your Financial Risk Factors
One factor you can control regarding interest rates is your own financial health. For example, if you have a high credit score, a low debt-to-income ratio and a 20% down payment, you can likely secure a better rate from the lender.
Lenders look at your credit score, current debts and the amount you put down on the home to determine how much they’ll charge. If you have low credit scores, high debt ratios, or a low down payment, your interest rate may be higher. If you’re in this situation, you may want to consider an FHA loan that caters to borrowers with lower credit scores or down payments and still offers competitive interest rates.
Who Are The Parties To A Mortgage?
A mortgage is a legally binding contract between the homeowners and the lender. The mortgage states how much borrowers must repay the lender each month, what interest rate they’ll pay, and how long they have to pay the loan.
The lender is known as the mortgage loan originator. Your originator may sell your loan to a different loan servicer after funding your loan. The loan servicer is the company you deal with when making payments or when you have questions about your loan.
In a mortgage contract, you, the borrower, are the mortgagor, and the lender is the mortgagee. You own the property and agree to pay the mortgage as assigned, and the lender agrees to follow your rights and responsibilities according to the agreement.
You may also see these terms pop up in your mortgagee clause on your homeowner’s insurance policy. The mortgagee clause is the wording on your homeowner’s insurance policy that guarantees the lender will receive payment from the insurance company if you had a total loss versus the insurance company sending the money to you while you still have a mortgage on the property.
How To Get A Mortgage: The Home Loan Process
The mortgage loan process requires steps for both the lender and homeowner to help ensure both parties have success with the loan. For example, you should be aware of how much you can actually afford to borrow. At the same time, your lender will use a process called underwriting to determine how much you may be able to afford.
What Can I Afford?
Before applying for a mortgage, you should have an idea how much you can borrow, which in turn tells you how much house you can afford. It’s important to remember that the amount you can realistically afford may be less than what a bank thinks you can.
A great way is to either get prequalified or preapproved. A prequalification is an estimate of what you can afford based on the verbal information you provide the lender. But, a preapproval holds more weight because lenders will only preapprove you once they’ve viewed and evaluated your income, asset and liability documents.
It’s important to keep your mortgage payment affordable. Be realistic about your monthly budget and use simple general rules of thumb, such as keeping your housing payment (principal, interest, real estate taxes, homeowner’s insurance, and mortgage insurance) at 28% or less of your monthly budget. You could also follow the 36% debt-to-income ratio rule, which considers your total debts (mortgage plus any other debts) and recommends keeping them below 36% of your income. The key is to avoid becoming house poor.
If you want to see how much you can afford, use the Rocket HomesSM Home Affordability Calculator to narrow down the right purchase price, down payment, and term to get the most affordable mortgage payment.
How Much You Qualify For Vs. How Much You Can Afford
There can be a difference between how much you qualify for and how much you can afford. A preapproval is based on an algorithm that considers your income, down payment amount, credit score and total debts.
It doesn’t look at your lifestyle, your grocery or utility bills or what you might have to sacrifice to take on the mortgage. In other words, through the system, you might qualify for much more than you can afford or want to pay. For example, you may want to choose a starter home versus a forever home to transition your way into homeownership while staying near the city.
How Do I Get Preapproved?
It’s easy to learn how to get preapproved for a mortgage. It starts with a loan application, and then you’ll provide the lender with the necessary information to prove your income, assets, and liabilities.
Typically you’ll need:
- Paystubs covering the last 30 days
- W-2s for the last 2 years
- Tax returns for the last 2 years, if you work for yourself
- Bank statements for the last 2 months
- Current liability statements
The underwriter will review the information and calculate how much you can afford based on the information provided. The underwriter will also determine what conditions you must satisfy to get to final approval and include them in your pre-approval letter.
Can I Look At A House Without Preapproval?
There’s no rule or law stating you need a preapproval letter to see a home, but without a preapproval letter, most real estate agents and/or sellers won’t take you seriously. Most sellers don't want to waste time with “nosy neighbors” or unqualified buyers. Even if they let you see the home, chances are they won’t accept an offer without a preapproval.
What Lenders Consider During The Preapproval Process
During the preapproval process, underwriters assess your creditworthiness. In other words, they determine if you can afford the loan by looking at the following factors.
Your credit score is one of the first things lenders consider when pre-approving you for a loan. The higher your credit score is, the more likely you are to get approved and have better terms, like interest rate. Some loans like FHA loans allow credit scores as low as 580. If you have bad credit, it’s important to learn the steps to improve your credit scores.
Your debt-to-income ratio (DTI) compares your monthly debt obligations to your gross monthly income (income before taxes).
To calculate your DTI, simply add up your monthly debts and divide it by your monthly income. For example, if your debts, including the proposed mortgage, are $1,800 and you make $6,000 per month, your DTI is 30%.
Each loan program differs, but a DTI of 43% or less is usually considered healthy and can typically allow you to secure a loan.
When you apply for a mortgage, lenders will consider the following debts when calculating your DTI:
- Proposed mortgage payment
- Minimum credit card payments
- Personal loan payments
- Student loan payments
- Car loan payments
- Alimony or child support payments
- Any other debt payments
It doesn’t include things like utilities, groceries, medical bills, insurance (except homeowner’s insurance) or any other living costs.
Down Payment Amount
Most loans, with the exception of VA and USDA loans, require a down payment. Your down payment is your investment in the home. The more money you invest, the less risk the lender takes and the more equity you’ll start with. Therefore, a higher down payment can often help with the approval of your loan even if you have a lower credit score or higher debt-to-income ratio.
Income And Asset Verification
Lenders may write a pre-approval letter based on the submitted information, but not verify it until you find a home and go through the underwriting process. Rocket Mortgage® takes the extra step and verifies your information during its Verified Approval Process.1 This extra step provides a more accurate estimate of what the buyer can afford and shows a stronger preapproval because it verifies the buyer is financially stable. This could give you the edge on the competition if you’re in a bidding war.
How To Shop For A Mortgage
According to a 2018 study by Freddie Mac, you could save $1,500 or more just by shopping around for a mortgage. So while it might take a little more work and time, it can save you a good amount of money on what is likely one of the largest purchases you’ll make in your lifetime.
Fortunately, shopping for a mortgage can be easier if you know the following information.
How To Choose A Mortgage Lender
Choosing a mortgage lender is a personal decision that can be based on a few different factors. Of course, you want a mortgage lender you work well with and that offers the loan programs you need, but there are questions every home buyer should ask their prospective lenders choosing a lender, including ones about fees, terms and qualifications.
In addition to interviewing lenders, look for lenders that have positive reviews and earned awards. For example, Rocket Mortgage has earned the J.D. Power award for Highest Customer Satisfaction for 8 years in a row.
APR: How To Compare Loan Offers
Many borrowers compare only the interest rates of mortgage loans, taking the loan with the most attractive offer, but this isn’t the best method to choose the right loan.
Many lenders advertise low-interest rates only to make up for the difference in the fees, which is why the annual percentage rate (APR) is a much better comparison. Today’s regulations require commercial lenders to disclose their APR plus any additional charges for a loan to help borrowers better understand which loan is the better fit.
APR vs APY: What’s The Difference?
Many borrowers confuse APR with annual percentage yield (APY), but they mean two different things. The APR refers to the interest plus fees on a loan on an annual basis. On the other hand, APY refers to the annual cost of the loan, including the compound interest. When it comes to your savings and investments, APY is interest you earn on savings or other investing accounts. When it comes to your mortgage, it’s the interest you pay to the lender.
How Can I Reduce Interest Charges On My Mortgage?
The interest rate is determined by several factors, including current rates, your credit score, the loan amount and your down payment. The interest rate reflects the risk the lender is taking with the loan. Luckily, there are some ways to reduce the lender’s risk and, thus, help reduce your rate.
Buy Down Your Interest Rate
You can pay mortgage points to lower your rate. Essentially, you pay interest upfront rather than monthly in your mortgage payment. Each point will reduce your interest rate by a certain amount, which varies per lender. For example, if one point reduces your interest rate by 0.25% and your original interest rate is 5.75%, your new interest rate will be 5.5%
One point costs 1% of your loan amount. For example, if you have a $200,000 loan, one point will cost you $2,000. Any points you pay are due at the closing, so your upfront costs will be more if you purchase points.
Increase Down Payment
You might get a lower interest rate if you have extra money to put down on your home. Lenders base your rate on the riskiness of your loan, but the more money you invest in your loan, the less you have to borrow and the less risk the lender takes.
Get A Co-signer
A co-signer helps ensure the loan will be paid, which can help lower the risk to the lender. That’s because the co-signer is legally obligated to pay the loan if you don’t.
It’s important to make sure you are confident you and the cosigner can afford the payment before putting yourself and another person in a bad situation. Before anyone co-signs for a loan, they must understand the liability it puts on them. If the borrower defaults, the co-signer becomes responsible for the payments. If no one pays the mortgage, it could damage the credit score of both the buyer and co-signer.
Types Of Mortgages
Choosing between the types of home loans can feel overwhelming, but by answering a few questions and narrowing down your options, it becomes a lot easier. The Rocket Homes home buyer's guide also provides all the information you need to help you become an informed buyer and make better lending decisions.
Fixed-Rate Vs. Adjustable-Rate Mortgage
The first decision you’ll make is between the fixed- and adjustable-rate loan. Both have pros and cons, and the right one will depend on each buyer’s financial situation and goals.
A fixed-rate mortgage is a mortgage that has an interest rate that stays the same throughout the life of the loan. You lock the rate in before you close, and that’s your rate for the life of the loan. It doesn’t matter if rates increase or decrease. Your rate never changes. The benefit of these loans is that if rates rise after you get your loan, your rate won’t. But if interest rates fall, you’re stuck with your higher rate unless you refinance.
Fixed-rate loans are a popular choice, but now that rates are increasing, more borrowers may be considering an adjustable rate mortgage (ARM).
Adjustable-Rate Mortgage (ARM)
An ARM has a fixed rate for a few years (the introductory period) and then adjusts annually based on its index and margin. Although there are caps on both sides, ARM loan rates can increase or decrease significantly. It’s important to understand that the initial rate only lasts for 2 – 10 years, depending on your loan’s term, and then the rate adjusts annually. The good thing about an adjustable rate is that the initial rate is typically lower than a fixed-rate loan. However, if rates rise, you run the risk of having a higher rate later. On the flip side, if rates lower, you could get an even lower interest rate.
You’ll want to make sure you’re in a good financial position where you’ll be able to take on higher rates if that happens with your loan.
Loan Term: 15- Vs. 30-Year Mortgage
Next, you’ll choose the loan’s term. This refers to how long you have to repay the loan, which will affect your monthly payment. The most common options are 15- and 30-year terms.
What Is A 30-Year Fixed Mortgage?
A 30-year fixed mortgage has a fixed rate for 30 years. This has its pros and cons.
- You don’t have to worry about the interest rate changing during the life of the loan
- Your monthly payment will be lower than a 15-year loan because you have more time to pay it off
- It can be easier to qualify for, especially if you have other debt
- You’ll pay more interest over the life of the loan because you borrow the funds for 30 years
- It takes longer to build equity
What Is A 15-Year Fixed Mortgage?
A 15-year fixed mortgage has a fixed interest rate for 15 years, which is half the time of the 30-year mortgage. Because you won’t have the loan as long, the lender is taking on less risk. That means you could get a lower interest rate.
Like the 30-year fixed mortgage, there are pros and cons.
- You could save thousands of dollars in interest
- You’ll build equity faster and own the home in full earlier
- Interest rates are usually lower
- You have less time to pay off the loan, so your monthly payment is higher
- It could be an opportunity cost to investing in retirement or for other purposes
Conforming Vs. Nonconforming Loans
Conforming loans are those that follow the FHFA lending regulations so they can be purchased by government-sponsored enterprises (GSE) like Fannie Mae and Freddie Mac. Nonconforming loans are those that don’t meet these requirements. In addition, lenders offering nonconforming loans must fund the loans themselves and keep them on their books.
What Is A Conforming Loan?
A conforming loan meets all Fannie Mae or Freddie Mac guidelines. This includes credit score, debt ratio, and down payment requirements. It also refers to the maximum loan amount borrowers can have. For example, in 2022, the conforming loan limit is $647,200 in most areas of the country. For high-cost areas including Alaska, Hawaii, Guam and the U.S. Virgin Islands, the limit is $970,800. Any loan over that amount is nonconforming.
Benefits Of Conforming Mortgages
Conforming loans have their benefits, including:
- Highly competitive interest rates
- Maximum affordability because of the due diligence lenders must do
- They’re available at most lending institutions
The Problem Of Conforming Loan Limits
As we said above, conforming loan limits are high, but not high enough for some homes or even some areas. If the loan limit in your area isn’t high enough to afford a home, you won’t be able to secure a conforming loan. This was a problem during the pandemic when real estate prices kept skyrocketing, pricing borrowers out of their loans.
When A Conforming Loan Is Not An Option: Nonconforming Loans
Sometimes, a conforming loan isn’t an option. If you’re self-employed, qualifying for a mortgage can be difficult. Also, conforming loans won't be an option if you don’t have a straightforward income or you take a large number of deductions and show a loss. Conforming loans have strict requirements regarding how your income is verified and only use the income reported on your tax returns. If you’re in one of these situations, nonconforming loans could be an option.
A jumbo loan is one type of nonconforming loan. Any loan over the conforming loan limit for the area is a jumbo loan, and Fannie Mae or Freddie Mac won’t buy them. However, jumbo loans have the same requirements as conventional loans (sometimes even tougher) because of their high loan amounts and increased risk of default.
The Jumbo Smart loan from Rocket Mortgage can be a great jumbo loan option as it requires only a 10.01% down payment (rather than the traditional 20% requirement for jumbos), there is no mortgage insurance, and you can borrow up to $2.5 million if you meet the credit score and down payment requirements.
Conventional Vs. Government-Backed Mortgages
Another loan option you might have to consider is a conventional loan vs a government-backed loan. Both loan types are favorable and have competitive terms, but they cater to different types of borrowers.
What Is A Conventional Loan?
A conventional loan is a traditional mortgage loan. You don’t need a 20% down payment like most people assume, though. Instead, you can get a loan with as little as 3% down if you’re a first-time homebuyer.
While a 20% down payment would allow you to avoid private mortgage insurance (PMI), it’s not required to get financed. Putting 20% down could cause other financial issues because you could deplete your savings. PMI, on the other hand, is a more manageable fee that’s added to your monthly payment and can be removed once you have 20% equity in your home.
Some lenders offer lender-paid mortgage insurance or single-payment mortgage insurance, giving you other options than adding PMI to your monthly payment. However, you might pay a higher interest rate if you have lender-paid mortgage insurance.
What Is A Government-Insured Mortgage?
A government-backed mortgage is a loan insured by the FHA, VA, or USDA. These government entities guarantee lenders will get repaid if a borrower defaults on their loan. This allows lenders to offer more flexible underwriting guidelines, like lower credit score requirements or 0% down payments. This can allow more people to buy homes sooner.
Other Types of Home Loans
Aside from the traditional loans discussed above to buy existing homes, there are a few other loan options you might consider.
A construction loan provides a temporary loan to build a house and then permanent financing (a mortgage) to live in it. There are single-close construction loans that offer both loans in one closing. When the building part of your home is complete, the loan transitions to a mortgage.
During the building phase, you can make interest-only payments on the money withdrawn to build the home. Once the loan converts to a traditional mortgage, you’ll make principal and interest payments.
Condo loans are used to buy condos for primary use or investment. Condo loans have specific requirements that must get passed to get financing. If you don’t qualify for conventional condo financing, you may qualify for FHA condo loans. However, the requirements for the condo are much stricter on FHA condo loans versus conventional loans.
A bridge loan is a short-term loan between two transactions. For example, if you’re selling a home to buy another, but the home you’re selling will take longer than expected, a bridge loan can provide the financing in the meantime.
Bridge loans are typically short-term, with a max term of 12 months, and they always use your home (current or new) as collateral.
If you bought a house in cash but later need the funds you tied up, you may qualify for a delayed financing loan. Essentially, it’s a cash-out refinance, providing access to the home’s equity. Since you don’t have a loan on it, you have 100% equity, so it’s easy to get access to the equity. Most lenders require you to keep 20% equity in the home.
Closing Day And Your Mortgage
Knowing what to expect on closing day is important. The more you know about the closing process, the easier it can be to get through closing day.
Mortgage Commitment Letter
Before you close, you’ll receive a mortgage commitment letter. This letter states the terms of your loan, the interest rate and monthly payments. It will also list any outstanding conditions and state that you’ll be approved for this loan once those conditions are met. A final letter is a firm commitment that you’ve met all of the requirements and that you will get your loan. The letter lets sellers and real estate agents know that the sale is set to go through successfully.
The Closing Disclosure document shows the costs to close your loan, the loan terms, and your projected monthly payments. You should receive the document 3 business days before your scheduled closing. This allows you enough time to review it, compare it to your loan estimate and ask questions. If there are any issues and the numbers change significantly, you’ll receive a new closing disclosure. Lenders must give you another 3 business days to look over the new document before closing.
The mortgage note gives the lender permission to hold your home as collateral. It also states the loan’s terms, including the interest rate, payment frequency and the amount of down payment.
Lenders often sell mortgage notes throughout the loan’s term. This doesn’t change your loan terms or any agreements, but it may change who services your loan.
Your Mortgage And The Role Of The Government And Investors
Once your mortgage is approved and closed, it takes on a life of its own. Here’s what you might expect.
Fannie Mae And Freddie Mac
Fannie Mae and Freddie Mac are two important government entities that keep the housing industry liquid and profitable. These government agencies play an important role in buying and selling mortgage-backed securities because of the importance of the housing industry to the American economy.
Liquidity And Stability For Housing Markets
Government-sponsored enterprises (GSEs) buy and sell mortgages. They also guarantee certain loan programs for lenders to keep the real estate industry liquid. By bundling mortgage securities and selling them to investors, lenders have more liquid capital and can keep lending to homeowners, helping the housing industry succeed.
Bundling and Offering Securities To Investors
Mortgage-backed securities are investments that include mortgage loans bought from lenders, bundled together with similar loans, and sold on the bond market to promote liquidity in the mortgage industry.
Creating Home Ownership Opportunities For Low-Income Wage Earners
Freddie Mac and Fannie Mae both have programs to help certain buyers, especially first-time home buyers who have moderate- to low-incomes or need additional help buying their first home. For example, the Freddie Mac HomeSteps program and Fannie Mae HomePath program have flexible underwriting requirements and low down payment requirements. In addition, they may provide down payment or closing cost assistance.
Mortgage-backed securities are considered safe investments. Many investors, including retirees looking to supplement their fixed income, look to diversify their portfolios with the safe investment opportunities that mortgages offer.
Paying Off Your Mortgage
Getting approved for a mortgage to buy a house is one thing, but then you need to know how to pay your mortgage off.
Every borrower will have a required minimum monthly payment. This payment may include the principal (the amount you borrowed), interest, property taxes, homeowners insurance, and mortgage insurance, if you’re required to pay it.
If you pay PMI on a conventional loan and pay your balance down to 80% or less of the original value, you can request that they cancel your PMI, lowering your payment.
Most borrowers today will have an escrow account, which is an account that collects a portion of your estimated real estate taxes and insurance each month, paying them on your behalf when they come due.
Borrowers with an adjustable-rate mortgage may have a different mortgage payment each year. Still, even fixed-rate borrowers may have a different payment if their real estate taxes or homeowners insurance increase, changing their escrow payment amount.
How To Pay Off Your Mortgage Early
You must make your minimum required payments each month, but you may also have the option to pay your mortgage off early. Here’s how.
Make Biweekly Mortgage Payments
Biweekly payments mean you make half of your mortgage payment every 2 weeks instead of the total payment once a month. Since there are 52 weeks in the year, you’ll have made 13 full mortgage payments at the end of the year. Since monthly payments only equate to 12 full payments in a year, that means you’ll make one extra mortgage payment each year. This can knock thousands of dollars of interest and several years off your loan term.
Recast Your Mortgage
If you come into a large sum of money, you can recast your loan, lowering the payment. After you apply the lump sum, you have a lower principal. A recast will reamortize the payments according to the new balance, saving you money in the long run.
If you don’t have a large enough lump sum to recast your loan, you can still pay extra money toward the principal and reduce the amount faster.
Refinance Into A Shorter-Term Mortgage
If your income has increased since you bought the home and you can afford a higher payment, consider refinancing into a shorter term, for example from a 30-year to a 15-year loan. Cutting your term in half will decrease the interest you pay by thousands of dollars and you’ll own your home in half the time. Just make sure you can afford the higher payment since your payments are spread out over less time.
How To Lower Your Monthly Mortgage Payment
No one likes a high mortgage payment, and there are ways to lower it depending on your circumstances.
Refinance Your Mortgage
Whether you’ve built equity in your home or you’re struggling to make your payments, there are refinance options for everyone. If you have equity in your home, you can refinance and possibly get a lower rate or better terms because of the lower LTV. You can also refinance to extend your loan term, giving you more time to pay off the loan and, thus, lowering your monthly payment.
If you’re struggling, contact your mortgage servicer to determine what mortgage refinance options they have for you. Many lenders offer a high LTV refinance or loan modification programs to help make your payments more affordable. You’ll want to make sure you understand the implications of refinancing. For example, you might reduce the equity in your home, may end up with a higher interest rate or could pay more interest long term because you’re extending the number of years you pay interest on the loan.
Get Rid Of Private Mortgage Insurance (PMI)
If you pay PMI because you put down less than 20% on your home, you may be able to cancel it once you’ve paid enough toward your mortgage and/or your home appreciated.
By law, your lender must cancel your PMI when you owe 78% or less of the home’s original value. But, if you think your home appreciated faster, you can pay for a new appraisal and request PMI cancellation.
Keep in mind, if you have an FHA loan, you have only two options:
- Wait until your MIP expires after 11 years. MIP only expires if you put at least 10% down.
- Refinance into a conventional loan once you owe less than 80% of the home’s value.
Should I Pay Off My Mortgage Or Invest?
If you have extra money, you may wonder if you should pay your mortgage off early or invest. Both options have their pros and cons. With either option, weigh your risk tolerance (how much can you stand to lose) and the opportunity cost of choosing one over the other.
Pay Off Mortgage Early
Some homeowners prefer to invest extra money into paying their mortgage off early. For some, the satisfaction and sense of peace that comes over you when you own your home free and clear can be reason enough to pay your mortgage off instead of investing.
Other reasons to pay your mortgage off early include:
- Saving money on interest
- Eliminating a large mortgage payment during retirement
- More financial freedom
There are downsides, too. If you put all your money in your house, you don’t have any liquid funds left. If you have an emergency or incur a large expense, you might have to take out more debt to cover it if you put all your money into your home.
There’s also no guarantee your home’s value will appreciate or remain steady. As we saw during the housing crisis, values can fall fast. Investing all your money in your home is like putting all your eggs in one basket.
Pay Off Mortgage Or Invest
When deciding to pay off your mortgage or invest, look at the big financial picture. Compare the interest you’ll pay on the mortgage balance for the rest of the term versus the potential return on investment you’d get by investing.
Keep in mind the risks you can take and your future financial goals when you look at these factors. Of course, there's no guarantee in home values or investment values, so there’s risk in both. It’s up to you to decide what you can handle.
Tax Benefits of Homeownership
Homeownership used to be one of the largest tax benefits anyone could have, but since the Tax Cuts and Jobs Act, those benefits have significantly decreased.
All homeowners are capped at a $10,000 property tax deduction each year, which in high-tax states, hurts homeowners significantly. Plus, the chance to write off the interest paid on your mortgage decreased significantly, too, since the standard deduction doubled from what it once was. Most taxpayers just take the standard deduction, which means interest doesn’t even play a role in lowering their tax liabilities.
What Happens If I Don’t Keep Up With My Mortgage Payments?
As we said earlier, your mortgage is a legally binding agreement. If you don’t keep up with your payments, you could face serious consequences.
If you miss a mortgage payment, you defaulted on your loan terms. One missed payment won’t trigger a foreclosure, but if you begin missing more payments, your lender may start the foreclosure process.
Even after one missed payment, you’ll get phone calls and letters in the mail asking how they can help you. You’ll also have late or missed payments reported to the credit bureaus, which can negatively impact your credit score. Typically, after four missed payments, they may start the foreclosure process and file legal proceedings to take possession of your home to get their investment back.
Judicial Foreclosure Vs. Deed Of Trust State
Each state has different laws regarding how lenders can proceed when a borrower defaults. If you live in a state with judicial foreclosure laws, the case must go to court, and the judge must give permission to foreclose on the property.
In a deed of trust state, court orders aren’t required. Instead, a trustee holds the title until the lien is paid off, and if you default on your loan, the trustee can sell the property to pay back the lender.
Consequences of Foreclosure
Not only does foreclosure mean you lose your home, but it can also damage your credit score significantly. It remains on your credit report for 7 years and can lower your credit score by 100 points or more. This can ruin your chances of getting future credit and sometimes even renting a home after losing your own.
The Bottom Line: A Mortgage Can Be Your Ticket To Homeownership
A mortgage is a type of loan that helps support dreams of homeownership. There are resources available today – from lenders, the government, and investment markets – to help people buy a house. While it’s exciting to own a home, it does come with certain financial obligations, especially if you’re borrowing money to do so. Before using a mortgage to purchase a home, it’s important to understand your responsibilities as a homeowner.
If you’re ready to take this next big step in your life, apply for preapproval online today!
1Participation in the Verified Approval program is based on an underwriter’s comprehensive analysis of your credit, income, employment status, assets and debt. If new information materially changes the underwriting decision resulting in a denial of your credit request, if the loan fails to close for a reason outside of Rocket Mortgage’s control, including, but not limited to satisfactory insurance, appraisal and title report/search, or if you no longer want to proceed with the loan, your participation in the program will be discontinued. If your eligibility in the program does not change and your mortgage loan does not close due to a Rocket Mortgage error, you will receive the $1,000. This offer does not apply to new purchase loans submitted to Rocket Mortgage through a mortgage broker. This offer is not valid for self-employed clients. Rocket Mortgage reserves the right to cancel this offer at any time. Acceptance of this offer constitutes the acceptance of these terms and conditions, which are subject to change at the sole discretion of Rocket Mortgage. Additional conditions or exclusions may apply.
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