A mortgage is a legal agreement between a homebuyer and a financial institution where the latter provides a loan to the borrower to cover most of the cost to purchase a home. Correspondingly, a mortgage refinancing loan is another form of a mortgage that allows a homeowner to borrow money, at a lower interest rate, to reduce their monthly home loan payment.
Borrowers who take out a mortgage loan pay interest on the loan (the amount of money the lender earns on the loan), usually over a 15- or 30-year period. Failure to repay a mortgage loan can lead to a home foreclosure, where the bank or financial lender pulls the loan and claims ownership of the property in question.
What Goes Into a Mortgage?
Primarily, a mortgage is comprised of four key elements - principal, interest, taxes and insurance.
This is the total amount of cash the mortgage lender agrees to provide to a homeowner to purchase a home. For example, if you take out a $250,000 home mortgage loan, you'll need to repay the entire $250,000 - plus interest.
This is the amount of money, expressed as a percentage tied to Federal Reserve and financial institution loan rates, that a borrower agrees to pay to take out a mortgage loan.
This is the amount of money, expressed as property taxes, you'll pay to own a home in your community. Property taxes are levied as a percentage of the perceived value of your home.
This is the amount of money you'll pay on a mortgage loan to cover your home and property. Mortgage insurance typically comes into play if a borrower makes a down payment of less than 20% of the home's selling price. That helps the lender reduce the risk of making a loan that the borrower may not pay back.
How to Apply for a Home Mortgage
When it comes to filling out your home mortgage loan application, the process doesn't have to be overwhelming.
Take these steps to ensure your home loan paperwork is in order and more likely approved:
Step 1: Be Prepared With Documentation
A good home buyer is a prepared home buyer. As you get ready to fill out your mortgage loan application, make sure your financial situation is in order. That means checking your credit report to see there are no errors or other surprises and having a decent down payment in place. Just as important, get the necessary financial documents in order. Make sure you have the following:
- A copy of any applicable purchase & sale agreement.
- Any current mortgage information, including monthly payments, taxes, and an estimation of housing expenses. If you have lived there for less than two years be prepared to include former home addresses dating back seven years.
- A two-year history of employment and verification of all income sources. Typically, your last several paycheck stubs and copies of the past two years federal tax returns will get the job done (the latter is mandatory if you're self-employed).
- Information about your checking, savings and credit card accounts. Two months' worth of bank statements and investment account information are acceptable. On the debt front, lenders typically don't like to see more than 20% of your estimated loan amount tied up in debt. Expect to include the outstanding balance of each of your debts.
- The Social Security number for you and your spouse, if you're buying the home jointly.
- The number and ages of your dependents
- Information regarding divorce decrees. Not all lenders require that you list divorce information - just don't be surprised when they do.
Step 2: Know Your Mortgage Options?
Primarily, home mortgages come in two varieties - fixed mortgages and variable-rate mortgages.
These mortgages allow you to have the same interest rate over the entire period of the loan, which usually ranges from 15 to 30 years. Know the risks and rewards going into a fixed-rate mortgage loan. If interest rates slide over time, you'll have to pay the higher interest rate you agreed to with your lender (although refinancing to a lower rate loan is an option.) On the other hand, if interest rates climb, your fixed interest rate deal with your mortgage lender insulates protects you from rising interest rates.
These mortgages come with interest rates that fluctuate over time, based on Federal Reserve rate decisions, bank lending conditions, and the state of the U.S. and even global economies. As economic decisions rise and fall, interest rates move up and down accordingly. A note of risk on variable rate mortgages: These mortgages often offer lower interest rates up front, with the strong possibility of those mortgage rates rising after a pre-agreed period of time (usually after five to seven years).
Step 2: Schedule a Mortgage Loan Application Interview
By now you've selected a mortgage lender you're comfortable with and who offers terms and rates that meet your home-buying needs.
Help your lender help you by scheduling a sit-down, either face-to-face, online or over the phone. That streamlines and simplifies the loan application process. Your loan officer will use the meeting to explain the types of mortgages that the lender offers, information on interest rates, home buying fees, and criteria needed to qualify for your home loan. Not only is this critical information that you should know, it also gives you a better framework for filling out your loan application.
In fact, in many cases, the lending officer will walk you through the loan application itself during the meeting. You may have to ask, and it's encouraged that you do so, but professional help is right there when you need it.
Step 3: Completing Your Mortgage Loan Application
Be thorough, careful and diligent in handling your mortgage loan application. Double check for errors and typos, and make especially sure that any financial data you're including is accurate and up to date. If a mortgage lender spots a mistake or views your loan application data as inaccurate, that's more than enough for the lender to reject your mortgage loan application.
Tips for Completing Your Mortgage Application
Use these tips to up the odds your mortgage loan applications sails through the very first time:
Fill out a mortgage application in advance
Thinking of buying a home but you're not ready to do so? Even if you plan on waiting six months or so before you buy, fill out a home mortgage application anyway - the exercise will leave you fully prepared for the application process and will also give you a good idea what you'll need to complete your loan application form when the real deal arrives.
Know what you can afford to pay
A big step is to tailor a mortgage that works for you, instead of the other way around. The key here is to identify what monthly mortgage payment you can afford without losing any sleep at night. Expect that figure to be around 15% to 30% of your monthly income (depending on your local tax rates and the amount of your homeowner insurance). You'll also want to review your credit report ahead of time to ensure that you're a good credit risk.
Get to know interest rates
By and large, your mortgage will be paid off either at a 15-year or 30-year timetable. As far as interest rates go, the shorter the time you'll need to pay off the mortgage, the more favorable your interest rate. And the lower your interest rate, the less your monthly mortgage payment will be. Consequently, job one when you go shopping for a mortgage lender is to compare interest rates, along with penalties and points (more on the latter two in a moment).
Don't plan on missing a loan payment
This may sound obvious, but if you don't pay your monthly mortgage loans, your lender can, at first, charge onerous late fees and penalties that add to your mortgage bill. In a worst-case scenario continued non-payment can lead to your home being repossessed by your lender.
Make no mistake, your mortgage loan is one of the most important - and one of the most complicated - personal financial deals you'll ever make in your lifetime.
That's why it's important to study up and get prepared, so you get the best deal on your loan.