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Mortgage 101: The Basics of Funding Your Home Purchase

By April 5, 2022April 23rd, 2022Article

Most first-time homebuyers use a mortgage to finance their home purchase. In fact, only 30 percent of U.S. home purchases in 2021 were paid entirely with cash.1 But understanding how mortgages work and what type will work best for you can be challenging.

What’s a Mortgage?

Put simply, a mortgage is a type of loan used to finance your home purchase. When you obtain a mortgage loan from a lender, they cover the cost of the home upfront to make up the difference between the sale price and your down payment. You must then pay the lender back in small increments over the loan’s term—usually 15 or 30 years. Your monthly mortgage payment doesn’t just go toward the loan’s principal—you’re paying for other expenses as well.

Can Your Mortgage Payment Change?

How consistent your payment remains over the loan’s term is primarily determined by the mortgage rate
you choose. If you get a fixed-rate mortgage, then the loan term and interest rate will remain consistent unless you refinance. This means that you may only see payment fluctuations due to changes in property tax rates, homeowners insurance rates, and PMI. If you get an adjustable-rate mortgage, you may see more substantial fluctuations after the first few years of your loan’s term, as the interest rate changes with the markets (typically every six months to a year).2 You should carefully review the loan terms to see how far up the interest rate can go, since this can substantially change the cost of your mortgage over time. *PMI is only be included if your down payment is less than 20% of the home’s value and will drop off once you’ve paid that 20%.

The Anatomy of a Conventional Mortgage Payment

Can Your Mortgage Payment Change?

How consistent your payment remains over the loan’s term is primarily determined by the mortgage rate you choose. If you get a fixed-rate mortgage, then the loan term and interest rate will remain consistent unless you refinance. This means that you may only see payment fluctuations due to changes in property tax rates, homeowners insurance rates, and PMI. If you get an adjustable-rate mortgage, you may see more substantial fluctuations after the first few years of your loan’s term, as the interest rate changes with the markets (typically every six months to a year).2 You should carefully review the loan terms to see how far up the interest rate can go, since this can substantially change the cost of your mortgage over time. *PMI is only be included if your down payment is less than 20% of the home’s value and will drop off once you’ve paid that 20%.

Types of Mortgages

Aside from fixed-rate and adjustable-rate mortgages, there are different types of mortgage loans that buyers can choose from based on their needs and qualifications as a borrower. This list isn’t comprehensive, so speak with your advisor about which loans are available for your unique situation.

Conventional Loan Jumbo Loan FHA Loan VA Loan
Conventional loans follow
standards put in place by
Fannie Mae and Freddie
Mac, the federally backed
mortgage companies
that set underwriting
guidelines for home loans.
Conventional loans are
lower cost but have a
higher barrier of entry than
some other kinds of loans.
Because jumbo loans
exceed FHFA borrowing
limits, they’re a great
option for buyers searching
for a home in a high-price
market. Since these loans
are high risk for the lender,
they have more stringent
qualifications than other
types of loans.
FHA loans are insured by
the U.S. Federal Housing
Administration. They’re
designed to help buyers
who don’t qualify for a
conventional or jumbo
loan, so their requirements
are more lenient.
VA loans are backed
by the U.S. Department
of Veterans Affairs and
are intended for members
of the military, veterans,
and their surviving
spouses that meet the
minimum active service
requirement detailed on
the VA website.6
Requirements to qualify:3 Requirements to qualify:3 Requirements to qualify:5 Requirements to qualify:3
Down Payment:
Minimum 3% down
Down Payment:
5–20% down, depending
on the lender
Down Payment:
Minimum 3.5% down
Down Payment:
No minimum
PMI: Applied if down
payment is less than 20%
PMI: Applied if down
payment is less than 20%
PMI: None, but buyers
must pay an Upfront
Mortgage Insurance
Premium (MIP) at
closing and an Annual
MIP for either 11 years
or throughout the
loan’s lifetime
PMI: None, but must pay a
funding fee at closing, or
roll into the loan
Credit Score: 620 minimum Credit Score: 680
minimum, with some
lenders requiring
720 or more
Credit Score: 580 minimum
for maximum financing,
but can be 500 to access
loans that finance 90% of
the home’s value
Credit Score: No minimum
DTI Ratio: 50% or lower DTI Ratio: Varies, but
generally 40% or lower
DTI Ratio: 43% or lower DTI Ratio: 41% or lower,
but may be waived if
other aspects of borrowing
history are strong
Conventional loans follow
borrowing limits set by the
Federal Housing Finance
Agency (FHFA) standards.3
You can find the most
recent limits on the
Federal Housing Finance
Agency website.
Jumbo loan borrowing
limits vary by lender.4
The borrowing limits for
FHA loans follow FHFA
standards.5
The borrowing limits for
VA loans follow FHFA
standards.6

 

When Choosing a Mortgage, Your Financial Health Matters

No matter which mortgage type sounds best at first glance, you must evaluate your full financial picture before looking at houses or pursuing financing. That means understanding your income, credit score, debt levels, and—most importantly—how a home will further your overall financial goals.

Sources
1. Katz, Lily. “Share of Homes Bought With All Cash Hits 30% for First Time Since 2014.” Redfin. July 15, 2021.
www.redfin.com/news.
2. Grace, Molly. “Why Does My Mortgage Payment Keep Changing?” Rocket Mortgage. February 4, 2022.
www.rocketmortgage.com/learn.
3. Fontinelle, Amy. “Mortgage Qualifications: How to Qualify for a Mortgage.” Credible. October 12, 2021.
www.credible.com/blog.
4. “Conventional Loans.” Consumer Financial Protection Bureau. www.consumerfinance.gov.
5. “Federal Housing Administration FAQ.” U.S. Department of Housing and Urban Development. October 1, 2020.
www.hud.gov/answers.
6. “VA Home Loan Limits.” U.S. Department of Veteran Affairs. February 9, 2022. www.va.gov.