What Is A Mortgage? The Basics For Beginners

Interest rates are the charges for the mortgage you’re seeking. Mortgage rates are determined by analyzing a wide variety of factors, some of which have nothing to do with either the lender or the borrower.

The interest rate is determined by two factors: current market rates and the level of risk the lender takes to lend you money. You can’t control current market rates, but you can have some control over how the lender views you as a borrower. The higher your credit score and the fewer red flags you have on your credit report, the more you’ll look like a responsible borrower. In the same sense, the lower your debt-to-income ratio (DTI), the more money you’ll have available to make your mortgage payment. These all show the lender that you are less of a risk, which will benefit you by lowering your interest rate.

If you’re shopping around – Freddie Mac’s research shows that soliciting even one additional offer can save borrowers $1500 on average – you’ll want to get the best rate possible for your mortgage. But lenders sometimes offer very low rates but charge a number of fees. To meaningfully compare mortgage offers, you’ll need to look at their annual percentage rate (APR).

The amount of money you can borrow will depend on what you can reasonably afford and, most importantly, the fair market value of the home, determined through an appraisal. This is important because the lender cannot lend an amount higher than the appraised value of the home.

Economic Conditions

When the pandemic hit in 2020, the Federal Reserve (the Fed) quickly dropped interest rates to discourage an economic recession. The Fed recently announced that interest rates will be rising in 2022 as they move to reduce inflation.

The Fed doesn’t set mortgage rates directly, but interest rates respond rapidly to changes in the Fed fund rate. Consumer loans are at the top of the borrowing risk pyramid, but mortgages are the lowest-priced of all consumer loans, because they’re secured by the property.

Fixed-Rate Vs. Adjustable-Rate Mortgages

Mortgages are structured in endless iterations, but they’re almost all either fixed-rate or adjustable-rate mortgages.

Fixed-Rate Mortgage

Fixed interest rates stay the same for the entire length of your mortgage. If you have a 30-year fixed-rate loan with a 4% interest rate, you’ll pay 4% interest until you pay off or refinance your loan. Fixed-rate loans offer a predictable payment each month, which makes budgeting easier.

Adjustable-Rate Mortgage (ARM)

Adjustable rates are interest rates that change based on the market. Most adjustable-rate mortgages begin with a fixed interest “teaser rate” period, which usually lasts 5, 7 or 10 years. During this time, your interest rate remains the same. After your fixed-rate period ends, your interest rate adjusts up or down every 6 months to a year. This means your monthly payment can change based on your interest payment. ARMs typically have 30-year terms.

ARMs are right for some borrowers. If you plan to move or refinance before the end of your fixed-rate period, an adjustable-rate mortgage can give you access to lower interest rates than you’d typically find with a fixed-rate loan.

Your Credit Score, Income And Assets

As we’ve noted, you can’t control current market rates, but you can have some control over how the lender views you as a borrower. Be attentive to your credit score and your DTI, and understand that having fewer red flags on your credit report makes you look like a responsible borrower.

To qualify for the loan, you must meet certain eligibility requirements. Therefore, a person who gets a mortgage will most likely be someone with a stable and reliable income, a debt-to-income ratio of less than 50% and a decent credit score (at least 580 for FHA or VA loans or 620 for conventional loans).

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