Mortgages 101

Explore the ultimate guide to home buying and refinancing. 

Introduction

Homeownership continues to be a big part of the American Dream. Many people strive to have the security and sense of pride that comes with owning their own home, but the path to homeownership can be challenging. Once you have saved enough to make a down payment on a house, you still have to find the right property and secure a home loan that fits your needs. A mortgage will probably be the biggest financial commitment you will ever make, so you should know how to find the right home loan.

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Chapter 1

An Introduction to Mortgages

There are many different types of home loans with different terms, tiers, and payment structures. Whether you are a first-time homebuyer or a homeowner looking for a new mortgage that better suits your needs, finding the right home loan can be daunting without the proper guidance.

Start by looking for a reliable lender. You want to look for a competitive loan interest rate from a mortgage lender that has a proven track record. It’s important to work with a mortgage lender worthy of your trust. For example, because mortgage brokers work on commission, an unscrupulous broker could try to get you into a more expensive loan than you need. 

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You also want to be able to rely on your lender to explain every aspect of the home loan; otherwise, you could be facing a balloon payment, or the loan rate could adjust to something you can’t afford. And if you work with a lender who has a limited selection of home loans, you could be short-changing yourself.

Because it is such a big financial commitment, your mortgage needs to be part of a larger financial strategy. You need to consider how your home purchase will affect your long-term plans, such as retirement, or whether you may want to use the equity in the home for a major expense such as college tuition.

Whether you are a first-time homebuyer or looking to refinance, we have the  right home loan to suit your needs. Apply today →

There is a lot you need to know about how mortgages work and what options are best for your situation. That’s why we have created this guide. You should also familiarize yourself with bank and mortgage terminology, so we suggest you review both our glossary of banking terms and our home loan glossary.

Chapter 2

Home Loan Basics

Every homebuyer’s financial situation is different, so there are different types of home loans to meet every need. Before you start discussing home loan options with a mortgage lender, you should be prepared with a working knowledge of the various home loan options.

Common Types of Home Loans

Here is a list of the most common types of mortgages:

  • Fixed-rate mortgage: As the name implies, this is a mortgage loan that charges an interest rate that is fixed for the life of the loan. The interest rate typically depends on the current prime rate or market rate, and most loans are for 30 years, although 15-year mortgages are also common. The advantage of having a fixed-rate loan is that the monthly payment does not change, which makes it easier to calculate home loan payments as part of your monthly budget.

  • Adjustable-rate mortgage (ARM): An ARM has an adjustable interest rate that fluctuates with the market rate throughout the life of the loan, although ARMs also have a rate cap so interest rates can’t increase beyond a certain percentage. Some ARMs adjust their rate monthly and others change their rates annually. Adjustable-rate loans can offer better short-term rates and can be useful if you plan to pay off the mortgage quickly or sell the home in a few years or if you can afford the rate changes and refinance in the future.

  • Conventional home loans: A conventional home loan is not guaranteed by a federal agency such as the Federal Housing Administration (FHA) or Veteran’s Administration (VA). They usually adhere to the down payment and income requirements set by Fannie Mae and Freddie Mac. For example, if you can make a 20% down payment, you don’t have to pay mortgage insurance.

  • Nonconforming home loan: A nonconforming loan does not meet the guidelines set by Fannie Mae and Freddie Mac, which can mean that the mortgage amount exceeds the limits set by the guidelines (also called a jumbo loan) or that the loan doesn’t require the same credit requirements or down payment requirements. Many financial institutions dislike nonconforming loans because they are harder to sell, but they can be useful when you need special dispensation for some aspect of the mortgage.

  • FHA loans: Backed by the Federal Housing Administration (FHA), FHA loans can be valuable for first-time homebuyers and buyers with credit or cash-flow issues. They require less stringent credit qualifications and require a lower down payment, sometimes as low as 3.5% of the home price. However, FHA loans do require you to pay mortgage insurance in advance for every year you have the loan, and loan qualification can be limited based on where you live because it is designed to fund less expensive homes.

  • VA home loans: The United States Department of Veteran Affairs (VA) offers home loans to qualified veterans and members of the armed forces backed by the federal government. VA loans offer a number of advantages, such as a lower down payment (as low as 3%), no requirement for private mortgage insurance (PMI), lower closing costs, and better interest rates.

Shopping for Interest Rates

Finding the best mortgage interest rate is important. Even a tenth of a percentage point on mortgage rate interest can translate to savings of thousands of dollars. However, it’s not just a matter of finding the lowest interest rate. You also want to find the best type of loan for your situation.

Whether you are a first-time homebuyer or looking to refinance, we have the  right home loan to suit your needs. Apply today →

We already mentioned the difference between fixed and adjustable-rate home loans. When shopping for a home loan, you want to compare interest rates from various lenders and brokers. Once you find a rate that looks appealing, you have to start looking deeper to uncover hidden fees and costs.

  • Interest rates: Determine if the quoted rate is the best for that day or that week; lenders change rates regularly. Also, ask if the rate is fixed or adjustable and, if it is adjustable, whether rates go down with the prime rate. Also be sure to ask about the annual percentage rate (APR), which takes into account not only the interest rate but also points, broker fees, and credit charges.

  • Points: Sometimes, you can pay fees to the lender or broker to reduce the loan amount by paying the interest rate in advance. This process is often called buying discount points. One point is 1% of the mortgage amount, and the more points you buy, the lower the interest rate. For example, if you buy a home worth $300,000, then one point is $3,000. In most cases, one point reduces the interest rate by 0.25%, so in this example, by paying an additional $3,000, you would reduce the mortgage interest rate from 4.00% to 3.75%. Be sure to ask about point fees as a dollar amount as well as loan percentages.

  • Fees: Any home loan will include additional fees, such as loan origination fees, broker fees, and closing costs. You should be able to get an estimate of fees in advance. You may pay some fees when you apply for the loan, such as application fees, and pay other fees as part of the contract closing. Some fees are negotiable or can be paid by the seller as an incentive to close the sale. Most fees are usually built into the home loan amount, but be sure you understand all the fees in advance.

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Other Home Loan Considerations

There may be other things to consider when shopping for a mortgage. For example, the criteria for first-time homebuyers is different than for those who have previously owned a home or want to refinance their home.

Most people who are seeking to refinance their homes are either looking for a better interest rate or want to extract home equity. By refinancing, you can cash out the difference between the higher home value and what you still owe on your mortgage and use that money for other expenses, such as home improvements, investments, or family emergencies.

There may be other special home loan options as well. For example, joining a credit union may give you access to better loan rates because credit unions are structured to help members achieve their financial goals. Credit unions also offer special loan deals, such as the special mortgage program for teachers and first responders offered by iQ Credit Union.

Some banks and credit unions also offer special services for homebuyers. iQ Credit Union has the HomeReady program for first-time buyers that offers home loans with as little as 3% for a down payment. HomeReady also allows you to use non-borrower income and offers other features to make it easier to qualify for a loan.

Chapter 3

Your Credit Score and Home Loans

Having good credit is an essential prerequisite for taking out a home loan. Because a mortgage is such a big commitment, the lender wants to be sure you are in a financial position to repay the loan, and they use your credit score to determine your creditworthiness.

Your credit score is a ranking between 300 and 850 that reflects how well you manage your money; the higher the score, the better your credit. Your credit score is based on your credit history, the number of accounts you have open, the amount of personal debt you have, and other factors that show the likelihood you will be able to repay a loan. Credit scores are maintained by the three national credit bureaus: TransUnion, Equifax, and Experian.

Whether you are a first-time homebuyer or looking to refinance, we have the  right home loan to suit your needs. Apply today →

Your credit and your credit score may affect the type of home loan you can qualify for. Each type of loan has different borrower criteria. For example:

  • To qualify for a conventional loan, you typically need a credit score of 620-640 or higher.
  • To qualify for an FHA loan, you need a credit score of 580 or higher to qualify for a lower down payment. With a credit score below 580, you may still qualify for an FHA loan, but you will need to have at least 10% of the purchase price of the home as a down payment.
  • To qualify for a VA loan, you don’t necessarily need to have a set credit score to qualify, although most applicants have a credit score of 620 or higher.

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Your credit score can also affect your mortgage interest rate because borrowers with good credit can get better rates. For example, borrowers with credit scores above 760 are considered to be very low credit risks and can qualify for loans that may be several points lower than advertised.

If you are considering buying a home, take the time to review your credit, make sure there are no errors in your credit history, and take steps to improve your credit score. You can usually get free access to your credit score and credit history through your bank, credit union, or credit card company. There also are free online services such as Credit Karma, Credit.com, and NerdWallet that can help you check your credit score and review your credit history.

Chapter 4

The Documentation You Need to Apply for a Mortgage

Before you start shopping for your new home, you want to make sure that you will qualify for a mortgage. Mortgage prequalification will reassure the seller that you have the funds available to make an offer to buy. It also gives you an idea of how much money you can borrow, which will dictate how much you can spend on a home purchase.

All you need to start home shopping is to prequalify for a mortgage; you don’t need preapproval. With prequalification, you provide a loan officer with information about your income, assets, debt, and related information, including a “soft pull” of your credit history, to determine if you can take out a home loan and for how much. Note that prequalification isn’t a guarantee of a loan because the estimates are based on the information you provide, but it should be sufficient to start looking at houses.

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Preapproval is a formal process that you undertake when you are ready to buy. You will need to show you have the money and are prepared to sign the sales contract. Preapproval later requires completion of a formal mortgage application as well as all the supporting documentation necessary for the application. Processing the mortgage application requires an extensive credit check, including a credit report, in order to approve the loan and lock the interest rate. It also requires you to estimate the amount of money you will need for a down payment.

Whether you are a first-time homebuyer or looking to refinance, we have the  right home loan to suit your needs. Apply today →

When you are ready to actually apply for a home loan, the mortgage lender will need specific paperwork and information:

  • Your credit score: The lender will access a complete credit report, including your credit score, credit history, and other information to determine if you are a good credit risk.

  • Tax returns: As part of your financial history, be prepared to share tax returns from the last two year to show adjusted gross income.

  • Pay stubs or proof of income: You will also need to be able to present proof of income, such as recent pay stubs. If you are self-employed or have other sources of income, you will need to provide proof of payment from those sources as well.

  • Bank statements: You will need to share the last two or three months of your bank statements to show your household expenses and how your income compares to your spending.

  • A list of assets: In addition to income, you also will need to provide a list of anything you own that has value, such as rental property, cars, and boats.

  • Your residence history: If you are a renter or already have a home, you will be asked how long you have been at your current and previous addresses. Lenders tend to take a closer look at borrowers who move frequently or show a lack of stability.

  • A photo ID: Prepare to present a driver’s license, passport, or some other form of government-issued photo identification to verify your identity.

  • Other materials: Be prepared to present anything that has an impact on your personal finances. This could be paperwork about divorce, child support payments, bankruptcy, a gift letter, a business license, or anything else that has an impact on your income or your credit history.

When you are ready to go house hunting, you only need a home loan prequalification. You won’t want to qualify for a loan until you are ready to actually buy. Prequalification is also much faster than preapproval, and you don’t need a credit report for prequalification.

Chapter 5

The Stages of Homebuying

Once you have prequalified, most lenders will give you 90 days until you have to requalify, which gives you three months to find the right property. Below are the basic steps most homebuyers follow: 

Step 1: Find a real estate agent.

With home loan prequalification, you have a good idea of how much you can afford to spend on a home, so the next step is to find a real estate agent. You want to work with an agent who understands your needs in a home and knows the area where you want to live. You should only work with one real estate agent at a time, and because all the agents share the same home listings, they should be prepared to show you potential properties that fit your price range.

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Step 2: Make an offer.

When you find the right house, your agent can help you write an offer. Depending on how motivated the seller is, the nature of the local market, likely competition for the property, and other factors, you may want to make an offer that is higher or lower than the asking price. If you have to bid higher, make sure the bid is still within your budget, and be prepared for the seller to come back with a counteroffer. You may also want to include contingencies, such as repairs or other conditions that the seller needs to agree to as part of the sale. Once the offer is accepted, you will need to pay 1-3% of the home price as earnest money. Most buyers apply for home loan preapproval during this stage.

Step 3: Conduct appraisals and inspections.

There are additional steps before the sale can be completed. Usually, a home inspection is part of the contingencies to ensure that there are no serious structural problems or other hidden issues with the property. You may also want to consider paying for additional inspections to look for issues such as pests, radon gas, or geological issues, as well as a land survey if there is a question about the property line. The lender will also want an appraisal of the value of the property before authorizing a home loan.

Whether you are a first-time homebuyer or looking to refinance, we have the  right home loan to suit your needs. Apply today →

Step 4: Finalize the deal.

Once all the inspections and the appraisal are complete and the contingencies are removed, you are ready to sign a purchase agreement. Whereas an offer is a request to enter into a deal, the purchase agreement is the legally binding document that outlines the exact terms of the sale.

Step 5: Secure insurance.

Before you can finalize the sale, you will need homeowner’s insurance. Insurance is required to protect you and the lender, so you will need coverage for fire, flood, theft, natural disaster, and other events. You should talk to your lender and your insurance broker to determine how much insurance you will need. Your insurance premiums can be included as part of your mortgage payments.

Once you find the right house, it can take from 14-60 days to close the contract, and another 14-45 days until you need to make your first mortgage payment.

Step 6: Close.

Closing is the final step to formally transfer the property. With closing come closing costs, which can make up 2-5% of the total home loan costs, so remember to include closing costs in your homebuying budget. Closing costs typically pay for:

  • Property fees, including fees for the home inspection and appraisal
  • Loan fees, including the application fee, attorney’s fees, prepaid interest, loan origination fee, discounts points, and mortgage broker fees
  • Mortgage insurance fees
  • Property taxes, annual assessments, and insurance fees
  • Title fees including title search, lender’s title insurance, and owner’s title insurance

Depending on the property, the type of home loan, and other factors, there may be additional paperwork and fees. Buying a home is a complex process with a number of steps, so work closely with your mortgage lender and your real estate agent to be sure you understand the requirements and costs associated with each step.

There is no formula for how long the homebuying process should take. A lot depends on market conditions, the number of properties available in your price range, and the area where you want to live. It normally takes 1-2 months to find the right property. Once you find the right house, it can take from 14-60 days to close the contract, and another 14-45 days until you need to make your first mortgage payment.

Chapter 6

Understanding Your Mortgage Statement

When you receive your first mortgage statement, there will be a list of different charges that may seem confusing. To help you understand exactly what you are paying on your home loan, here is a list of the most common items listed in a mortgage statement.

Principal: The principal is the portion of the original loan you are paying that month.

Interest: Interest is the portion of the payment applied to the loan interest. Many home loans are structured to pay more interest in the beginning, so don’t be surprised if the interest charged is higher than the principal.

PMI: Private mortgage insurance (PMI) protects the lender in the event the borrower defaults. PMI is typically charged for home loans when 20% or less of the home value is made as a down payment.

Escrow or Impound Account: This is a separate account that is maintained by the lender to pay for property taxes and homeowner’s insurance, so the homeowner doesn’t have to set aside money to pay those annual expenses. The amount charged for the impound account may change with insurance premiums and tax rates.

 

Chapter 7

How Much Mortgage Can You Afford?

The big question for every first-time homebuyer is, “How much house can I afford?”

When they start planning to buy their first home, people tend to be excited and very optimistic, which means they may be looking to spend more on a house than their family budget can handle. The cost of housing varies depending on where you live, and although there is no one formula, there are a number of ways to estimate how much you can reasonably afford to pay each month for your home.

The long-standing guidance set by the United States government is that you should spend no more than 30% of your gross income on housing. That standard was developed for renters in 1969, but it remains relevant today, and you can use it as a starting point to calculate home loan payments. A new study from the Joint Center for Housing Studies of Harvard University shows that nearly 10.9 million renters, which represents 25% of renters, spent more than half of their income on housing in 2018. According to the study, the renter cost burden has increased for people of all incomes.

The 28/36 rule might make more sense for your household budget. This is a common-sense rule used by many mortgage lenders that says you should spend no more than 28% of your gross monthly income on housing expenses, and that housing debt should be no more than 36% of your overall monthly debt.

Whether you are a first-time homebuyer or looking to refinance, we have the  right home loan to suit your needs. Apply today →

There are regions where the cost of living is more expensive, and you should plan to spend more on housing if you live in one of these areas. Portland, Oregon, for example, ranked number 18 in Kiplinger’s top 20 most expensive cities, and housing costs are 82% above the national average. What is considered affordable housing will vary based on where you live. A Brookings Institute study shows that the total cost of your house should be about three times your annual income to be affordable. 

To determine how much you can afford to pay for a home loan, you should create a comprehensive household budget calculating all your expenses compared to your monthly income. When calculating income, you want to differentiate the amount of income you can apply to housing each month and the amount of income you can use to qualify for a home loan. Lenders are interested in your ability to repay the loan, so they may consider annual bonuses, tips, alimony, and other sources of income to help you qualify for a mortgage. Your total taxable income may not be an accurate reflection of your monthly paycheck.

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When calculating how much home you can afford, how much you can apply as a down payment is an important factor. Most mortgage lenders expect you to have 20% of the home price as a down payment. First-time homebuyers have an advantage because they can usually qualify for a home loan with a down payment as low as 3%. Naturally, the higher the down payment, the lower your monthly mortgage payments. You should discuss the down payment with your lender during the prequalification process.

Lenders use different criteria to determine if you qualify for a home loan, including income and debt. You may be earning a good income, but you need to be aware of your debt-to-income ratio (DTI), which is the amount you owe each month compared to what you take in. As a general rule, lenders want to see a DTI of no more than 43%, meaning that 43% or less of your monthly gross income goes to pay recurring debt such as student loans and credit cards. If your DTI is lower than 43%, it increases your chances of qualifying for a mortgage.

Finally, when considering how much to pay for a home, think about your future plans. For example, if you are just starting your career, your income may increase over time, which may mean you can prepay your mortgage to reduce the interest charges. However, you don’t want to try to spend more on a home than you can comfortably afford. Part of good personal financial planning is making sure you are conservative with your spending and maintaining an emergency fund to cover three or more months of expenses, including home loan payments.

Chapter 8

When to Refinance Your Home Loan

Chances are that after you buy your home, you will want to refinance with a new home loan at some time in the future. Things change, and you may want to take advantage of lower interest rates, tap the equity in your home, opt to pay down your mortgage faster, or apply for a new home loan for some other reason.

When to Refinance

There are a variety of reasons that you may want to refinance your home loan:

  • You want a better interest rate. As interest rates adjust downward, you could save a lot of money by applying for a new home loan at a lower rate. Refinancing can cost between 2-5% of the loan amount with application and loan fees, but the savings over time could make it worthwhile.

  • You want to move from an ARM to a fixed-rate loan. Adjustable-rate mortgages can be valuable if you are buying your first home or if you plan to move in a few years. However, they can become expensive as market rates fluctuate and loan terms change, so many people opt to refinance their ARM as a 30-year fixed interest home loan.

  • You want to pay down your mortgage faster. If your financial situation improves and you want to pay off your mortgage faster, you can refinance your 30-year home loan to a 15-year loan or some other type of mortgage.

  • You want to lower your monthly payment. As your home equity increases and market interest rates change, you might be able to refinance your home loan to get a lower monthly payment.

  • You want to use your home equity. Your home is probably the biggest purchase you will make in your lifetime, and the good news is that it will likely appreciate in value. By refinancing your home, you can access your home equity—the difference between your outstanding home loan principal and the higher value of your home—and use that money for home improvements, retirement funds, investments, or something else.

You want to avoid foreclosure. If you run into financial trouble due to job loss or an unforeseen emergency (such as the COVID-19 pandemic), you can avoid defaulting on your home loan by refinancing, renegotiating the terms of the loan so you can start fresh.

Calculate How Much You Could Save by using a Refinance Calculator →

How to Refinance

Applying to refinance your home loan is the same process as applying for your original loan, but before you begin, take stock of your financial situation and determine what has changed. Take a look at your household budget and determine how your income has changed. Assess your debt-to-income ratio. What does your credit score look like? Determine if you are prepared to modify your home loan.

Calculate How Much You Could Save by using a Refinance Calculator →

Also, take a look at market conditions. Most home loans are refinanced to find a better interest rate, but the difference between your current rate and a new interest rate has to be enough to make the additional loan fees and savings worthwhile.

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Once you decide to refinance, follow the same steps you took with your original home loan:

  • Shop for a lender you can trust to meet your needs.
  • Complete the loan application
  • Lock in the rate.

In many ways, the refinancing process is simpler because you are not negotiating a home purchase, which means you don’t need to deal with prequalification.

You also will encounter the same processes to refinance as you did with your original loan:

  • You will need to complete a loan application, including paying a loan application fee.
  • You will need to pay mortgage insurance.
  • You will need to conduct a title search.
  • The lender will require a home appraisal.
  • Some lenders require a complete home inspection.

Some financial institutions will absorb some of the refinancing loan fees. Credit unions, for example, often give their members a break by waiving the application and other fees.

Chapter 9

iQ Credit Union and Your Mortgage

When shopping for a lender, trust is essential. You want to work with a financial institution that you can rely on to give you the best rate and that will take the time to understand your financial and personal situations to help you find the best loan.

Many borrowers prefer credit unions like iQ when applying for a home loan because credit union members often can get better rates, more comprehensive answers, and better service. When you join a credit union, you become a member, not just a customer, and credit union loan professionals are more willing to work with you to explain financing options and develop a strategy that fits your long-term financial plans. Unlike larger financial institutions, credit unions tend to be more flexible, and loan officers can make lending decisions based on individual circumstances rather than a rigid loan approval formula.

Whether you are a first-time homebuyer or looking to refinance, we have the  right home loan to suit your needs. Apply today →

iQ Credit Union, for example, serves our neighbors in the Pacific Northwest as a trusted resource for home loans because we know the area and the real estate market. iQ has a wide range of home loan programs structured to meet our members’ needs:

  • Home Loans: iQ offers home loan options for first-time buyers, homeowners, members looking for a vacation home, and others. Options include special VA home loans and special rates for teachers and first responders.

  • HomeAdvantage®: The HomeAdvantage® Rewards program provides cash rewards up to $1,500 when you use a trusted real estate partner to help with your home purchase.

  • Home Loan Refinancing: iQ loan officers are experts at refinancing, including strategies to reduce your interest rate, cash out your home equity, or take on a second mortgage.

  • Home Equity Line of Credit (HELOC): If you want to use the equity in your home but aren’t ready to refinance, iQ offers a home equity line of credit (HELOC) that lets you tap your home equity as you need it.

  • InsureQ: InsureQ offers homeowners insurance plans to suit any need.

iQ Credit Union is committed to being a trusted resource for all our members’ banking needs. If you are interested in a home loan, feel free to stop into any iQ Credit Union office and talk to one of our team members. We want to be your trusted partner when it comes to each step of your financial journey.  

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