The home buying process can seem intimidating – but it doesn’t need to be. This guide will walk you through everything you need to know about mortgages – from the mortgage basics like getting a mortgage to the ins and outs of mortgage finance and the nuances of the different types of mortgages -- so, when it comes time to put down roots, you can do so with confidence.
What is a mortgage?
What is a mortgage? If you were thinking that a mortgage described a specific type of loan – you’re not alone. In actuality, the official definition for a mortgage is a legal document that pledges a property to the lender as security for payment of a debt.
So, what is the difference between mortgage vs loan? While a mortgage is the term for a legal document – as mentioned above – some may also use the term to refer to the type of loan used to purchase a home. But home loan, mortgage, or other colloquial phrase – the ins and outs of mortgage finance are relatively the same across the board.
Often, these terms are used so interchangeably that the exact definitions don’t matter – unless you’re a lawyer or a bank – if you say mortgage, most people will understand that you are also talking about the type of loan in addition to the legal document.
How does a mortgage work?
How does a mortgage work? There are many ways a to implement a mortgage. Explained simply: a mortgage is a contract you enter with a lender whereby they provide funds to purchase a residence in exchange for holding some rights to the property should you fail to repay those funds back in full.
As a result, your lender may charge interest, require the funds to be paid back within a specific timeframe, or have other requirements. All of these things go into making up your monthly mortgage payment.
The mortgage process explained
Mortgage rates explained
Usually, when someone says “mortgage rate” they are referring to your home loan’s interest rate.
How does interest on a mortgage work? Interest is money charged by the lender in exchange for loaning you the money to purchase your property – it makes up a small portion of the total cost and is the “profit” a lender makes on a loan. And it can have a big impact on your monthly payment.
For example, if you purchase a $100,000 home with a $10,000 down payment, you will take out a loan for $90,000. With a 3.29% interest rate on a 30-year mortgage, you could expect to pay nearly $250 per month just in interest. A 4% interest rate would bring that amount up to $300 per month. At 5.5%, you’d be paying more than $400 – just in interest.
And, while that amount is rolled into your monthly mortgage payment, it is not the only piece making up your monthly bill.
What to know about mortgage amortization.
What’s in a mortgage payment?
There are several terms you’ll need to know when looking for a mortgage. We’ll go over a few of the most important ones – the ones that make up your payment – below; but if you want to know more, feel free to peruse our Mortgage Glossary for other terms you’ll likely come across in your homebuying journey.
Principal
Principal is the amount of money you borrowed when you secured your mortgage. Every month, you make mortgage payments that go towards paying down the principal balance. On your monthly mortgage bill, you will typically see a sum total of your principal payment plus interest.
Interest
The fee charged for borrowing money.
Taxes and insurance
Includes property tax – determined by where you live and your property’s assessed value – and the homeowner’s insurance plan you select when you officially apply for a mortgage.
Mortgage insurance
A contract that insures the lender against loss caused by a mortgagor's default on a government mortgage or conventional mortgage. Mortgage insurance can be issued by a private company or by a government agency.
Flood Insurance
If your home lies within a flood plain, your mortgage lender may require flood insurance, which is wrapped into your monthly mortgage payment.
Why am I required to pay a mortgage insurance premium?
The mortgage process in five stages
Now that you’re closer to understanding mortgages, what are the requirements to get a mortgage? In other words, what do you need for a mortgage? We’ve broken down the mortgage process into five simple steps.
1. Calculate what you can afford
Generally speaking, housing costs should not exceed 28% of your gross monthly income – so carefully go over your finances and utilize helpful mortgage payment calculators to determine what you can afford to pay each month.
- Use our calculator to find out how much home you can afford.
2. Get pre-approved or show proof of funds
Fill out a mortgage pre-qualification application with a lender. You’ll need to prepare copies of your bank statements, most recent pay stubs, tax returns, and W-2s. Preapproval will show you how much funding you can secure and gives you an edge as you begin your house hunt. If you have all your documents in order, pre-approval typically takes just a few days to come back – some lenders can even accomplish the process in a few hours.
Or, if you’re planning to pay in cash, make sure your funds are liquid and available and prepare documentation showing proof of funds, such as recent bank statements.
2. Make an offer on a house
Once you find a home you like, it’s time to submit an offer. This is where you offer the seller a certain amount of money to purchase the home – this is typically based on both the home’s perceived value, as well as the sale price, your pre-approval amount, and current market trends. If homes aren’t selling quickly in your area, you may be able to offer less money that the home’s asking price. If homes are selling very quickly, you may want to offer a higher amount to make your offer stand out from those of other buyers. The seller can then accept or reject your offer. A seller can also negotiate the price with you, asking for you to submit a higher offer. This exchange is called a counteroffer.
Typically, your realtor mediates the offer process.
3. Get final approval
Once you’ve had an offer accepted, you’ll need to get final approval on your home loan. This is when a mortgage loan enters the underwriting process – where the conditional agreement of a pre-approval becomes a solid promise of payment. In essence, final approval is drawing up a contract with your lender. It can be a longer, more complicated process, and you will likely have to submit additional documentation proving you have your downpayment amount – and may even need to grant your lender the ability to “observe” your active bank accounts. It’s important to note that your final approval amount can be different from your pre-approval amount, and that many lenders will not lend you more than the agreed-upon sale price of the home. This process can take anywhere from 7 to 14 business days and can be longer if you don’t have all your documentation prepared ahead of time. If you are going with a fixed-rate mortgage, this is also the time when your interest rate becomes “locked,” and you get an idea of how property taxes will impact your monthly mortgage payment – your lender will provide you all of this information in a document called a “closing disclosure”, which you should read over carefully and thoroughly.
4. Close on your new property
If everything goes smoothly, you’ll proceed to closing! This is where you sign your mortgage, get the deed to your new house, and pay your down payment, closing costs, and any other outstanding fees. You’ll also need to cover things such as title costs, PMI, escrow fees, etc. In some cases, the seller pays the buyer’s closing costs if negotiated as part of the purchase agreement.
Types of mortgage explained
In this section, you’ll find the types of mortgage explained, and we’ll also go over the best type of mortgage loan for first-time home buyers as we discuss different types of home loans.
Conventional loans
This is your classic mortgage loan and is typically offered through a bank or other financial institution. To qualify for a Conventional Loan, you need to have a certain credit score and downpayment amount.
Fixed rate mortgages
A fixed rate mortgage is a mortgage where the interest rate remains the same throughout the life of the loan. This is a feature of a mortgage rather than a “type,” and can thus be applied to many different types of loans. For example, you can have a conventional mortgage with a fixed rate, or an FHA mortgage with a fixed rate.
Adjustable rate mortgages
An adjustable rate mortgage (ARM) on a home loan comes with a flexible interest rate that changes over the life of the loan. Some ARMs offer initial fixed interest rates for three, five or seven years and then adjust over the remainder of the loan term. Compared to a fixed rate mortgage, an ARM mortgage offers a lower initial interest rate, but after the fixed rate period ends, monthly payments typically fluctuate up or down, depending on the market. Like a fixed-rate mortgage, this is a feature of other types of mortgages – however, not all lenders offer ARMs, and an adjustable rate cannot be applied to all mortgage types. Talk to your lender to learn if they offer ARMs and what their requirements are for an ARM.
Government-backed loans
Some loans are backed by the government – including United States Department of Agriculture (USDA) loans and Federal Housing Authority (FHA) loans.
USDA loans are available to buyers wanting to purchase properties located in a rural area.
An FHA loan makes homebuying more accessible to a wider array of buyers, with lower credit score and down payment requirements.
Jumbo loans
A jumbo mortgage is a type of home loan used to finance properties that are significantly more expensive than the average home. Jumbo mortgages are generally reserved for affluent buyers who purchase a home requiring a loan amount that exceeds the conventional loan limit. On average, interest rates and down payments are higher, and jumbo mortgages are generally paid off in equal monthly payments. They can have 15- to 30-year terms.
Other mortgage types
First-time Homebuyer: What is a first-time home buyer loan? A first-time homebuyer loan is a mortgage loan designed with first-time buyers in mind. Typically, these loans have lower down payment requirements and may even have downpayment and closing cost grants available.
What you need to know as a first-time buyer.
Hometown Heroes: First Merchants’ Hometown Heroes program assists buyers who are first responders, medical professionals, non-profit employees, and school educators.
Construction Loans: Home construction loans are designed for those seeking to finance the building of their own home, and often converts to a regular mortgage once construction is complete. However, construction loans may have shorter repayment terms as well as more stringent credit requirements and higher interest rates.
Next Horizon: First Merchants’ Next Horizons Mortgage program is a first-time homebuyer program that offers down payment assistance to first-time buyers – as well as other benefits – to help them get the keys to their dream home. Our Community Home Lenders can help you determine if you’re eligible for our Next Horizon program.
How to choose a mortgage lender
How you select a mortgage lender is up to you. However, we suggest considering the reputation and longevity of the company and loan officer, the level of attentiveness they provide, their ability to be agile and adapt to changes in the market, and the variety of loan programs they offer. You can research lenders online or ask family and friends to recommend lenders they know and trust.
First-time homebuyer? First Merchants is here to help
Finding a home can be an intimidating yet rewarding process for a first-time homebuyer. We recommend working with an expert who can help you navigate the process step by step. Our attentive mortgage lenders have years of experience and are ready to help you start this exciting journey. Meet your local lender.
Mortgage FAQs
How long does it take to approve a mortgage?
Typically, getting final approval on a mortgage can take anywhere from 7 to 14 days. In order for everything to be processed in a timely manner, be sure to have all requested documentation ready for the underwriting department, and try to schedule your home inspection and appraisal as soon as possible – many lenders will not give final approval until an appraisal has been performed. Your lender will arrange for an appraiser to come out.
Can I be denied a mortgage after being pre approved?
Yes. If your debt ratio increases, if there is a change in income, or if you start a new job you may be denied a mortgage, despite being pre-approved. The underwriting process is also a closer examination of your finances, credit history, and debt-to-income ratio – it is possible for your lender to determine the loan is too risky during this time. This is why it’s very important to have your finances in order, and for you to be in good standing during the full homebuying process.
Do mortgage pre approvals affect credit score?
It depends. Some lenders may perform what is called a “soft credit check” in order to grant pre-approval. This is a very basic, preliminary check that does not impact your score. However, others may pull a full credit report, which can ding your score. Your lender should be able to tell you which method they use. This is why it’s important to think carefully about which lender you want to use – if you get multiple pre-approvals from multiple lenders, it can negatively impact your ability to qualify for the home loan you need.
At what stage can you pull out of a mortgage?
If your offer is accepted, you’ll enter the “due diligence” period, where you have time to get a home inspection and appraisal completed. If the appraisal comes back too low, or the home inspection turns up major issues you are not prepared to take on, you will have the option to withdraw your offer. Keep in mind, depending on your purchase agreement, there may be penalties for doing so.
What is the difference between a mortgage broker and a mortgage lender?
A mortgage broker works on your behalf to find a mortgage bank, so you can secure a home loan. By contrast, a mortgage lender approves you for a home loan and lends you the money to buy a home. Whether you choose to work with a mortgage broker or directly with a mortgage bank, ensure you’re getting the best loan terms and interest rates available to you. Also, carefully examine any fees or additional costs the broker or lender may charge.
Should I consider an online mortgage?
Whether you should consider an online mortgage depends on what you value most. Generally, borrowers considering an online mortgage rank convenience and speed as top priorities when financing a home purchase.
Many banks with brick-and-mortar locations also serve as online mortgage providers, giving buyers the option to complete the process online or in person. When choosing whether an online mortgage is right for you, it comes down to personal preference. Get started with an online application today.
What are mortgage points? Are they worth the cost?
Mortgage points are a one-time fee you pay your lender at the closing to reduce your mortgage interest rate. One mortgage point costs 1% of the mortgage loan amount. While mortgage points increase closing costs, a lower interest rate over the life of the home loan reduces monthly mortgage payments and the amount of interest paid. To really know if mortgage points are worth it, try comparing the cost of the points at closing with the amount of anticipated savings in interest paid. This anticipated savings varies based on the amount of time you plan to stay in the home or whether you plan to refinance in the near future.
How long will I be paying off my mortgage?
The length of time it takes to pay off a home mortgage depends on the specific loan terms. First Merchants offers several mortgage solutions, including a 15-year mortgage and a 30-year fixed mortgage. Shorter mortgage terms typically come with a higher monthly payment, but the homebuyer pays less interest over the life of the loan.
