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Understanding Mortgages

Helen Hackworth

As a real estate broker, my job is to help you find a house within your budget. None of your personal financial information is ever disclosed to me unless you share it with me. You establish what you can afford by working with a lender. You can obtain a mortgage from most banks or credit unions, but I also know some great local mortgage lenders who specialize in providing great service at competitive rates with regular communication.

There are several pieces to a mortgage and it can be very confusing, so let’s define a few terms first.

Principal: This is the amount of money you’re asking a lender to give you so you can purchase a home.

Equity: This is the amount of the house that you actually own. If you take the market value of your home and subtract the total amount of your mortgage, this is the amount of equity you have in your home.

Down Payment: This is the amount of money you’re willing and able to put forward out of your own funds toward the purchase of your home. The more money you put down, the less you have to finance through a mortgage. It’s important to put down as much as you possibly can within your budget so your debt will be less. Some lenders have higher standards than others and will ask you to put more money down. It is not a bad thing to put more money down. The more, the better. Some lenders require a minimum of 3-5% down payment.

Interest: This is the cost you pay to your lender on a monthly basis for borrowing money from them.

Amortization: Throughout time, as you make monthly payments, the principal balance of your mortgage will go down. The interest is calculated each month on that principal balance, so each month as that balance goes down, the interest you pay will go down slightly. At the same time, the principal portion of your monthly payment will go up slightly. You will receive an amortization schedule of your payments from your lender. You can also calculate this from other various sources or I can email you an Excel spreadsheet that I use frequently. If you make extra principal payments on top of your regular payments, your mortgage will amortize more quickly and you’ll pay off the debt more quickly.

Property Taxes: Your local municipalities (city, county, state, school district, etc) determine an assessed value of your home and apply the same rate as anyone else in your neighborhood to that value to decide what taxes you should pay annually.

Homeowner’s Insurance: You’ll need to obtain insurance to pay for the replacement value of your home and contents should damage occur to it. I can help you find an insurance broker if you don’t already have one.

Title Company: The main purpose of the title company is to research the title of the house, to transfer it from one party to the other, to insure a clear title on the property and to transfer the funds between all parties. They also make sure the contract, deed and related paperwork are fully signed and notarized, and filed with the county.

Escrow: The title company utilizes a non interest bearing escrow account during the closing process to temporarily place all the funds and disburse them to the appropriate parties (buyer, seller, insurance, taxing authorities, realtors, HOA, etc). Your lender will also utilize an escrow account to pay your property taxes and homeowner’s insurance on your behalf during the life of your loan. They estimate these values at the beginning of the year and pay them for you and then charge you on a monthly basis to cover those costs. The escrow amount fluctuates from year to year as your taxes and insurance rates change.

PMI: Private Mortgage Insurance is insurance that you’ll automatically pay as part of your house payment. It is designed to protect your lender in the event that you don’t pay. This portion of your payment will be removed upon your request once your loan-to-value ratio has fallen below 80%. What this means is that if you put 20% or more down on your house, you’ll never have to pay this part.

Closing Costs: There are several fees that you’ll settle up on closing day and you won’t pay these until that time. These include such things as title transfer fees, HOA dues, prorated taxes, etc. Before we get too far along with the process, I’ll work with the title company to help you have an idea of these costs before we are at the closing table. As a home buyer, most of the time you won’t pay me any realtor’s fees since those are typically paid by the seller.

Earnest Money: This is money (typically 1%) that you will need to pay to the title company once our contract is executed. This is part of the total cost you pay for the home and will be deducted on the day of closing when we settle everything.

Option Money: This is money (around $100 to $200 depending on the house) that you will pay directly to the seller and is intended to pay them for the convenience of us being able to get into their home during the option period to bring our inspectors in.

Option Period: This is a period of time (about 7 days usually) that you can back out of the contract for any reason and have your earnest money refunded to you.  Once this time has expired, you are fully obligated to proceed with the contract.

Inspection:  Inspections protect you and give you an overall picture of the condition of the home. Inspectors are very thorough and will send you a detailed report of their findings so that you can make an informed decision regarding moving forward with the purchase and/or negotiating any repairs to be done by the seller. I have a few companies that I regularly work with and this is a cost that you need to be ready to pay during the option period. The cost is usually $300-$500 depending on the house.

My Advice
Put as much money down as you possibly can. Keep in mind that there are always unforeseen costs to owning a home. Even though you’ll pay for an inspection and you will likely get a home warranty, you may also have some repairs/updating to do after you move in. And you might want to buy some new furniture or appliances. Getting a zero down loan is not a good thing. This just means that you went 100% into debt on your home. There are a lot of factors that go into their requirements, but if you put more money down on the front end, you are financing less and your total debt and monthly payments will be less. Sometimes when we’re negotiating with sellers, you look more attractive as a buyer by putting down more money. And I would highly encourage you to put down at least 20% so you won’t have to pay PMI insurance which doesn’t benefit you anyway. I would encourage you to pay off as much debt as you can before purchasing a home. It is a good idea to make sure that you end up with a total house payment (principal, interest, taxes, insurance, PMI) that is less than 25% of your monthly take-home pay. Lastly, I would advise you to look for a 15-year mortgage rather than a traditional 30-year mortgage because they obviously are paid off in half the time.

Here’s a short article from one of my colleagues in local lending who does a good job explaining the steps in the mortgage process.

Now that you’re armed with all this knowledge, I would suggest looking at a good online mortgage calculator and going to a lender to get pre-qualified so we can go house hunting and get on with the fun part of the home buying process!

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