Home Loans Described Simply

You’re finally ready to purchase your first home. You’ve spent years saving up enough for a down payment, and committed full days to researching exactly the type of property you want. At this point, your dream house is all yours!

Don’t let the loan officer’s intimidating calculations stop you from getting your white picket fence, because we’ve gathered all the essential info you’ll need to strut up to your lender confident that you can secure that mortgage.


Fixed- And Variable-Rate Mortgages

If you are looking at your first home loan, chances are you are going to want to go with a fixed-rate mortgage. However, that doesn’t mean you shouldn’t be prepared to know your options from the jump.

There are two basic mortgage types, fixed-rate and variable-rate. The key difference between the two loan structures is all in the name. A fixed-rate mortgage locks in your interest rate at the “completion” of the loan, which is actually the legal start of the mortgage, whereas the interest rate on a variable-rate mortgage will, fittingly, vary over the course of the loan.

What this means for the prospective homebuyer is that fixed-rate mortgages have a predictable repayment structure over the term of the loan, with no alarming surprises as the federal interest rate rises and falls. Because the interest rate is set at the start of the loan, homebuyers are in a better position when the federal interest rate is low or is anticipated to rise in the future.

Variable mortgages are adjusted with current interest rates. So a hike from the Federal Reserve means higher monthly payments for the borrower. Additionally, terms and fees can vary greatly from lender to lender, and borrowers need to be extra savvy to sort through the particulars of their lender’s loan contract. The borrower’s monthly payments almost always begin at a lower rate than that of fixed-rate mortgages, however, this introductory period is temporary. Once that low-rate period ends, unprepared borrowers can be in for a shock if their monthly payments suddenly double.

While you should keep your options open when considering how to approach buying your first home, the relative transparency of fixed-rate mortgages are your best bet in avoiding unwanted surprises from your lender in the future.


Principal, Interest, and Getting the Best Rate

First and foremost, the best thing you can do to guarantee a preferential interest rate—the percentage of the principal that is added to the total cost of the mortgage as the lender’s premium for granting the loan—is to make as large of a down payment as is feasible. The recommended amount is at least 20% of the home’s value. In most cases, any amount below that will require either the lender or borrower to purchase mortgage insurance. Of course, the cost of insuring the loan will be passed along to you, the borrower.

Another option for lowering your mortgage rate is shortening the term of your loan. However, that will mean higher monthly payments, which may not be ideal. You can play around with a mortgage calculator to understand the basic physics of these loans.


Fees and APR

What you should concentrate on now is the bottom line of everything. On top of the loan’s principal and premium, there is also:

  • a closing fee,
  • an underwriting fee, and
  • origination fee: the fee charged by the lender to create the loan, usually 1% of the principal

All of these costs are part of the loan that you are responsible for paying. While you should research common fee structures within each lender’s mortgage plan, the APR listed in every home loan quote is the simplest way to know the bottom line for you, the borrower.

APR, or Annual Percentage Rate, is your annual rate of payment when calculating the principal, premium, and some of the fees attached to your loan. Lenders are required to provide this number as a simplified means of comparison for borrowers.

However, when looking at a lender’s quoted APR, it is important to know that not all of the additional costs may be included. For one, some outside fees, like appraisal and title fees, are not included in that calculation. Also, many mortgage lenders only list the nominal APR, which does not include compounding periods, which can add to what you are actually paying each year, or your Effective Annual Rate.

APR is a helpful tool when choosing a lender and can key you in on where you might find the most preferential rate. Nevertheless, you should still do your due diligence as you narrow your options by researching exactly what each quote does and does not include, and consulting an outside party to understand what your EAR will look like.


Make the most of your current mortgage

Now that hopefully have an idea of what to look for with your first home loan, there are a few additional things to should consider to make your time as a borrower as short and painless as possible.

First, if you did opt for a fixed-rate mortgage and interest rates seem to be on decline, you can refinance your mortgage after several years to reflect current federal interest rates to potentially knock off a few thousand off of your bottom-line. The value of this will depend on how far rates have fallen, but it is generally a good idea to consider this option after a few years with your lender.

However refinancing does introduce the issue of a prepayment fee, which your lender will charge if your yearly payment exceeds a certain percentage of the principal, usually around 20%. Refinancing could trigger this fee.

Another point of caution to consider in terms of a prepayment fee is that some loan agreements also charge prepayment when you sell your home before the bulk of the mortgage has been repaid. This can be a big surprise to first time borrowers, so again, be aware of all of the terms behind a loan agreement before you sign.

Finally, once you have found the perfect home loan to fit your needs, don’t be shy about making an extra payment or two each year if your agreement permits. Because the majority of your minimum payments for the first half or more of your basic 30-year fixed-rate mortgage will be going to pay down interest, the principal that the interest amount is based on will remain largely intact. Making an extra payment a year towards reducing the principal amount can help to substantially reduce the total amount of interest you will wind up paying.