Home Buyers' Guide

What is a mortgage?

A mortgage is simply a loan used to purchase property, usually a house. Getting a mortgage is the biggest financial event in most peoples' lives, so it's important to understand how mortgages work and how to shop for a mortgage so you get a good deal.

Why should I get a mortgage?

Houses are expensive, but a mortgage loan lets you pay for a house over a long period of time – typically 30 years – and at a relatively low cost, making it much more affordable.

Modern mortgages are one of the great financial innovations of the 20th century and are one of the best ways for Americans to build wealth.

How does a traditional mortgage work?

Most folks get what's called a “traditional” mortgage, which means that it lasts for 30 years and has a fixed interest rate. Sometimes you'll here these called “30-year fixed” mortgages.

Here's how they work in simplified terms:

• You'll have 30 years to pay back the loan in 360 equal monthly payments (30 years = 360 months). This makes it affordable to borrow large amounts of money, many hundreds of thousands of dollars for most buyers.
• Your interest rate stays the same for 30 years, even if mortgage rates change, which means your monthly payments also stay the same for 30 years. This makes your monthly payments predictable and ensures you don't have to worry about your loan getting more expensive over time. This is great if you expect interest rates to go up over time because you're locking in a good deal If interest rates happen to go down, you can always refinance into a lower interest rate
• The loan is “fully-amortizing”, which means that by the end of the 30-year term your loan will be completely paid off.

While most home buyers take out a 30-year fixed-rate mortgage, sometimes a different type of mortage, like an Adjustable Rate Mortgage (ARM) can be a better fit. A Loan Officer can help you find the right loan type for you.

Key mortgage terms

You're going to hear a lot of jargon as you go through the home financing process. Our Loan Officers are always here to help if you have questions, but there are a few key concept and terms every home buyer should understand.

Let's say you want to buy a house that's priced at $100,000.

Down payment: most lenders require you to pay for some of the house out of your own pocket so you have “skin in the game”. This is called a down payment. Most buyers put about 10% down, or $10,000 in this case.

Loan amount: this is the amount you borrow to buy a home. Since the house costs $100,000 in this example and you're putting in $10,000 out of your own pocket, the loan amount will be $90,000.

Loan term: This is length of your mortgage in years or months. Most buyers choose a 30-year term, but there are other options and we'll make sure we find the right one for your personal financial situation.

Interest rate: the annual cost of your loan. In our example, if you borrow $90,000 at 5%, you'll pay ~$4,500 per year in interest. In reality it's a bit more complicated than this and you'll pay a bit less in interest every month as you pay down your principal balance.

APR vs APY: the APY (or Annual Percentage Yield) is the baseline interest rate on your loan – 5% in our example above. Most loans have some additional upfront fees (typically 2-3% of the loan amount) to cover the costs of processing your application (which can take 30-50 hours of work across 5-8 different people behind the scenes). The APR (Annual Percentage Rate) is an all-inclusive annualized rate – it includes the baseline rate and any additional fees.

Mortgage pros and cons

A mortgage makes buying a house accessible and affordable for many Americans and can help them steadily build wealth. While you do end up paying a lot of interest to the lender, when viewed through the lense of opportunity cost (which we'll explain below), there are very few downsides to a traditional mortgage. However, some alternative types of mortgages can carry significant downsides and buyers should always be aware of predatory lenders. That's why we recommend working with an experienced mortgage broker to ensure you get the right mortgage for you with a trustworthy lender.

By way of example, let's look at the purchase of home at the median national price of $400,000 with a traditional mortgage:

• Sale price: $400,000
• Down payment: $40,000 (10%)
• Loan amount: $360,000
• Loan term: 30 years
• Fixed interest rate: 5%
• Monthly payment for loan principal and interest: $1,933
• Loan balance at the end of year 30: $0
• Total interest paid by the end of year 30: $335,720

As you can see, you'd only pay $40,000 out-of-pocket to get a $400,000 home and your monthly mortgage payment would be $1,933. This monthly mortgage payment is comparable to rent in many areas of the country, but, with a mortgage you're building equity (wealth) in your home whereas with rent all your money is going straight to your landlord.

Mortgage benefits

You can buy a home with a small down payment

This means you don't need to have the cash on hand. If you're fortunate enough to have enough cash to buy a home outright, it also means that you don't necessarily need to use all that cash – you could leave it invested where it may earn a higher rate of return.

Mortgage down payments are also flexible – you get to choose how big it is based on what you can afford and how much you want to pay.

A note on Mortgage Insurance

One important thing to know about down payments: if they're less than 20%, you will have to pay for mortgage insurance. Mortgage insurance protects the lender from the risk of you falling behind on your monthly mortgage payments (it's separate from homeowner's insurance). While most home-buyers end up getting mortgage insurance, if you can afford to put 20% down we recommend doing so.

Monthly payments are similarly in size to rent

Because mortgages are typically paid back over 30 years and have relatively low interest rates, your monthly payment will typically be pretty close to what you would expect to pay in rent for a similar house.

You build equity (wealth) with every payment you make

With any fully-amortizing mortgage, you'll be building wealth by owning more of your home each and every month.

You may benefit from tax deductions

Most mortgages qualify for the Home Mortgage Interest Deduction, which can save you some money on taxes. Figuring out whether it's worth taking the deduction is a bit complicated so we recommend consulting with a tax advisor.

Mortgage drawbacks

You pay interest

While the 30-year term makes your monthly payments affordable, it also means your holding the lender's money for a very long time. Even at low interest rates, the absolute amount of interest you end up paying on the loan is significant. However, there are two things to keep in mind:

• If you don't have the cash today to avoid getting a mortgage, how long would you have to wait to save enough money? For most first-time home buyers, the answer is over 10 years. Do you really want to wait that long to start enjoying the benefits of owning your own home?
• If you do have enough cash today, would you be better off investing most of it in a different asset class? Since mortgage interest rates are still relatively low by historical standards, you would get more diversification and may be able to get a higher rate of return by investing most of the money somewhere else. Consult a financial advisor to learn more.

Common types of mortgage loans

There are three types of mortgage loans that make up over 90% of loans, each catering to a different kind of home buyer:

• Conventional loans: Conventional loans are the most common type of mortgage, taken out by ~70% of all home buyers. A conventional loan usually requires a credit score over 620 and a down payment of at least 3%. “Conventional” just means that the loan is not insured by the federal government.
• FHA loans: FHA loans are the second most-common type of mortgage, taken out by 15% of all buyers and 23% of first-time home buyers. The program is ideal for borrowers with lower-than-average credit and income, but many home-buyers with good credit go with FHA because it has a minimum down payment of just 3.5%. FHA loans are insured by the Federal Housing Administration.
• VA loans: VA loans are the third most-common type of mortgage, taken out by ~9% of all home-buyers. You must be an eligible current or former service member of the United States Armed Forces to qualify for a VA loan. The biggest benefits of a VA loan are the 0% down payment option and lower interest rates. The VA mortgage program is backed by the Department of Veterans Affairs.

Each of these programs has a lot of different loan options that can be custom-tailored to your specific financial situation.

How do I get a mortgage?

There are three steps to getting a mortgage:

• Pre-approval: Submit a short application to see if you qualify
• Application: Submit a full application with supporting documentation
• Closing: Sign all the loan paperwork to close on the loan

We'll break down each of these steps below with what you need for them and how long they usually take.

Step 1: Mortgage Pre-Approval

When to start this step: we recommend starting this step as soon as you start researching homes so that you know your budget, even if you don't have a real estate agent yet. Most sellers won't even consider an offer if the borrower hasn't been pre-approved, so this is a critical first step towards achieving your home ownership goals.

What happens: at this step, we'll collect a few pieces of basic information about your financial situation via a short online form and instantly let you know whether we think we can find a loan that works for you. There's no commitment at this stage.

What you need on-hand:

• Your name (easy, right?)
• Your social security number
• Your estimated annual income
• Your bank username/password
• Where you want to buy (could be a specific address or a general location)

How long it takes: a few minutes with Afford, up to a week with a big bank. With Afford, we can make a read-only connection to your online accounts to verify your income, employment and assets quickly and securely, saving you the tedious exercise of finding old tax forms and pay-stubs. We're using technology to build a better borrower experience, while other lenders are stuck in the past, asking borrowers to fill out long forms and send in copies of their bank statements and tax returns, which can take many days of back-and-forth conversations. Why wait a week to know if you get pre-approved when you can do it in minutes?

What does it take to get pre-approved?

Each loan type has different eligibility requirements, which is why it's so helpful to work with a broker like Afford that can quickly find the right loan for you. In general, though, we're always going to look at a few things to see if you're qualified: your income, debt, credit score, and assets.

What kind of credit score do I need for a mortgage?

A good rule of thumb is that if you've got a 620 or above you can get pre-approved for most types of loans (assuming no other issues). For borrowers with less than a 620, conventional loans are off the table, but most of the government-backed loans are still available. Afford can help you figure out which loan option is right for you based on your credit score.

What should my debt-to-income ratio be for a mortgage?

Your debt-to-income ratio (DTI) is your total monthly debt payments (including your estimated mortgage payment) as a percentage of your gross monthly income. Here are some rules of thumbs for common DTI ranges:

• 36% or less: you're in great shape; nearly all loan options are available
• 36% to 43%: you're in good shape; plenty of loan options available
• 43% to 50%: you're in fair shape; only a few loan options available
• More than 50%: a mortgage may not make sense financially at this time

All lenders and brokers, Afford included, use your DTI to make sure you can afford your mortgage payments. We would never want to put someone in a situation where their mortgage causes them financial distress.

How do I calculate the debt-to-income (DTI) ratio?

Let's say you're applying for a mortgage with your spouse and combined, you both earn $120,000 per year, your monthly income would be $10,000.

Let's say you're currently renting for $2,000 per month and you have the following monthly debt payments:

• Car payments: $550
• Student loan payments: $250
• Credit card debt: $500

Finally, let's assume your estimated monthly mortgage payment (including principal, interest, taxes, and insurance) is ~$2,200.

So your total debt would be $550 + $250 + $500 + $2,200= $3,500.

To calculate your DTI, we simply divide $3,500 by $10,000 to get 35%.

How big does my down payment need to be?

While many home buyers think they need a 20% down payment, the reality is that minimum down payment amounts are actually quite a bit lower as you can see below:

• VA loan: 0% down payment required
• USDA loan: 0% down payment required
• Conventional loan: 3% down payment required
• FHA loan: 3.5% down payment required

Note: these minimums usually assume good credit. Borrowers with lower credit scores may have higher required minimum down payments.

Are there other out-of-pocket costs when getting a mortgage?

Yes, you will also need cash to pay for closing costs. Some of these costs are directly related to your mortgage – processing, appraisal, and underwriting fees all go towards paying for the work that happens behind the scenes to quickly get your loan set up. Other fees are payments to third parties involved in the transaction, such as a title insurance company, an escrow company, the county recorder's office, and sometimes the local tax agency.

On average, closing costs come out to about 3% to 6% of the loan amount. So on a typical $400,000 mortgage, closing costs could easily be $12,000 or more. When you submit an application with Unified National, we'll provide you with an official Loan Estimate that details all of your closing costs.

Many first-time home buyers have a bit of sticker shock when they see the estimated closing costs on their Loan Estimate. We want you to be aware of it early so that you can budget for it by keeping enough cash on hand and so that it doesn't detract from the excitement of getting to that step in the process!

Step 2: Mortgage Application

When to start this step: we generally recommend going through this step about a week before you start writing offers to give you a better chance of winning your desired home (since you can prove to the seller that you can close quickly).

What happens: at this step, we'll collect more detailed information about your financial situation to be able to complete a formal Loan Application. You may be asked to pay a small fee for a credit report, but there is still no other commitment on your part at this stage. We are required to pull a “hard” credit report from one of the credit bureaus to fully verify your credit history, which means there will be a small (usually 5-point) impact on your credit score.

What you need on-hand:

• Proof of your income/employment (e.g. W-2's, pay stubs)
• A specific address

How long it takes: processing a full Loan Application can take anywhere from a few hours if you've already been Pre-Approved to a few days. When it takes a while, most of the time is usually waiting for borrowers to find the right documentation and send it in.

Step 3: Mortgage Closing

When to start this step: once you're in contract with a seller. Your real estate agent will make sure that we get notified at the right time.

What happens: at this step, you don't have to do much as it relates to your mortgage other than reviewing the Closing Disclosure and signing some paperwork, but there's a lot going on behind the scenes to ensure that the money is ready by the time you need to close on the property.

How long it takes: getting “cleared to close” from Afford usually takes two to three weeks for a typical home. More complex transactions can take longer. We will always tell you up-front how long we think it will take to close.

FAQs

Do I have to keep my mortgage for 30 years?

No, you can pay it back or refinance it at any time:

If you sell your home before your mortgage is paid off, the remaining loan balance will be paid off using the proceeds from the transaction (the title/escrow company will make sure this happens).

If interest rates drop, you may want to refinance to get a lower monthly payment. You'll basically get a new mortgage that replaces the first one.

Do I own my home when I have a mortgage?

Yes, you own your home. Decisions about the home are 100% in your control. However, other parties do have certain rights related to your home. For example, if you don't pay your property taxes, the state can seize it to force you to pay taxes. If you repeatedly don't make your monthly mortgage payments, your lender can take control of your property and sell it to recoup their investment.

While that may seem scary, just remember that as long as you hold up your end of the agreement you've got nothing to worry about.

Is a mortgage the same as a home loan?

Yes. “Mortgage” means the exact same thing as “home loan”.

Can you buy a house without a mortgage?

Yes, it's possible and around 20% of houses are purchased that way. To do so, you'd need to have enough cash in the bank to pay the sale price of the house plus any closing costs. Most home buyers don't have enough cash saved up to do that and it is often better to get a mortgage than to pay cash, even if you could afford it.

Do I have to pay mortgage insurance?

If you get an FHA loan, you'll be required to pay an upfront mortgage insurance premium (UMIP) at closing and then a monthly mortgage insurance premium (MIP) for the duration of the loan.

If you get a conventional loan and have a down payment of less than 20%, you'll be required to pay private mortgage insurance (PMI). You can proactively request that the lender drop PMI once your home equity reaches 20% (although this often requires an appraisal). Fortunately, the loan servicer is legally required to drop PMI automatically once your home equity reaches 22%.