Purchasing a house entirely with cash can take more than 20 years of saving. Using a mortgage is the only way to buy an expensive real estate without waiting for many years of saving. A mortgage is a long-term loan allowing you to buy a house or other real estate, such as a rental or commercial real estate. After purchasing a home with a mortgage, you start making payments, usually in equal monthly installments, and the house becomes collateral if you default on the loan. If you cannot repay the loan, the lender takes the property through foreclosure.
When you apply for a mortgage, lenders run your credit check. Most mortgages require a down payment, except for government-backed programs such as VA and USDA loans. The required down payment is usually between 3% and 20% of the final sales price, and terms generally range between 15 to 30 years.
Here is everything you need to know about mortgages and tips to qualify.
What Is A Mortgage?
A mortgage, also known as a lien against a property or a claim against a property, is a legal agreement between lenders such as banks, credit unions, and borrowers. In this agreement, the bank gives you the money in exchange for a regular monthly payment and interest. The lender puts a lien on the property until the principal and interest are fully paid off.
Most mortgages have 15, 20, or 30-year terms. A longer term comes with a lower monthly payment, but the house costs you more interest charges due to holding the loan for a long time. You might also qualify for either a fixed or variable rate on a loan. The difference between the two is that fixed-rate mortgages mean the interest does not change over the loan’s lifetime, while variable rates change over time based on changes in market rates.
Before you buy a house with a mortgage, you must save for the required down payment. For example, if you purchase $300,000 with a conventional mortgage, you must put down at least $60,000, 20%, to avoid private mortgage insurance(PMI). By putting down $60k, you will borrow the remaining $240,000.
Benefits of using mortgages
With a mortgage, you can make a big purchase without waiting many years of saving to pay off the entire house with cash. You can put down some money and use the mortgage to cover the remaining balance. This system allows many people to own homes and other properties without exhausting their financial resources or sacrificing other financial goals, such as retirement savings.
For example, if you are a veteran, you can buy a house without putting a dime down, and the lender might not even require a credit score. On the other hand, if you use an FHA loan, you will put down as little as 3.5% in the down payment and cover the remaining balance with a mortgage.
Types of mortgages
Mortgages come in many forms and types, but the most popular are 30-year fixed-rate mortgages and 15-year fixed-rate mortgages, based on the kind of interest rate you pay. The benefit of having a fixed rate is consistent payment for the duration of the mortgage. That is, your payment will stay the same, no matter the changes in interest rates. For variable-rate mortgages, the interest on the loan goes up and down depending on market rates.
Here are other types of mortgages you can consider when buying a house.
- Conventional mortgages. With this type of mortgage, you can put down as little as 3-5% of the final sales price. However, a 20% down payment is required to avoid purchasing private mortgage insurance. The minimum credit score needed to buy a house with a conventional loan is 620.
- FHA loans. These loans require as little as a 3.5% down payment for a credit score of 580 or higher or a 10% minimum down payment for a credit score between 500 and 579.
- USA loans are for borrowers who want to buy houses in eligible rural areas. These loans usually do not require a down payment, but the lender might require a credit score.
- VA loans. If you are a veteran, you can easily purchase a house with a VA mortgage. VA loans do not require a down payment or a credit score.
- Jumbo mortgages. These large mortgages are usually not backed by Fannie Mae, Freddie Mac, or any government agency. The limit you can borrow in a jumbo mortgage differs from one state to another, and the minimum required down payment is 20-25% of the final purchase price.
You might also like this list of the best loans for buying a house.
How do you qualify for a mortgage?
Lenders have a list of things they check when you apply for a mortgage. Use the following tips to increase the odds of qualifying for a mortgage when buying a house.
- Increase your credit score. A good credit score helps you qualify for a lower interest rate on the loan and increases creditworthiness. A credit score of 720 or above is essential when applying for mortgages, especially conventional loans, although you could qualify for a credit score of as low as 620.
- Have the required down payment. You might be required to put some money down depending on the loan program you use. Most loans require at least 3-5% of the total cost of the house. But, you will be required to purchase a PMI if you don’t have the required down payment.
- Lower your DTI ratio. Lenders rely on many factors, including your debt ratio, to evaluate the risk of lending you money. A higher DTI ratio means you have too much debt already, increasing the chances of default. Most lenders prefer a DTI ratio of 28% or lower. Some lenders, however, can approve you for a mortgage for a DTI ratio of as high as 41%.
- Have proof of income. Without proof of income, no lender will give you money. Most lenders require a 2-year consecutive employment. Tax returns or paystubs are some of the documents you can use as proof of employment.
- Have proof of address and identification. Most countries require you to be a citizen or a permanent resident to get a mortgage, so you must also have proof of ID and address.
Read the complete guide on How to get approved for a mortgage
Final Words
You must do your homework if you buy a house using a mortgage. There are a ton of lenders out there, and none of them will be good for you unless you pick the most with lower rates and favorable terms. Having the required down payment, increasing your credit score, lowering your DTI ratio, and getting pre-qualified is always the best way to start.
