(This post is part of our Free First Time HomeBuyers’ course. For more information and/or to sign up, click on this link, or select ‘Education’ under the ‘Buy’ drop-down menu above.)
Let’s start from the very beginning- since we can pretend to know it all as much as we want, but understanding all this jargon is really important. This isn’t microeconomics- let’s just be real and simple here.
What is a mortgage?
A mortgage is a big, fat loan.
But, where a loan might let you borrow up to $10,000, a mortgage lets you borrow a lot. How much? That depends on what you’ve got. Most lenders recommend a mortgage to cover 80% or less of the cost of the house (leaving you with 20% or more financial responsibility). So basically, if you’re buying a $100,000 house, you should get a mortgage for $80,000 or less. Meaning, you pay $20,000 (or more) as your contribution.
We call that the down payment. The greater down payment you can make, the more money the lender will be willing to give you. This means you can either get a more expensive house, or pay off more of a less expensive house. So with $30,000 you could consider…
Your house then acts as collateral for that amount- meaning, if you can’t make the mortgage payments, they take your house. It’s like how cars get repossessed- except it’s called a foreclosure and it’s even lamer. So, making that monthly payment is a big deal.
A mortgage’s monthly payment is based on four things:
- The total amount of money you borrowed from the lender. So, if you have a $200,000 mortgage loan, the beginning principal balance is $200,000.
- This is the money that you pay to the lender on top of what you borrowed (the fee they charge you for borrowing the money).
- Good ol’ Uncle Sam wants a cut too- every month property taxes are owed, and vary depending on the value of the property.
- A lot of times, you are required to get homeowners insurance by your lender to cover your house and possibly the property inside. Typically for conventional loans, if your down payment is less than 20%, you will have to pay mortgage insurance which protects the lender if you default (foreclose) on your mortgage loan.
Fantastic. Excited yet?
It may seem like a lot- and it is. You don’t want to sign on for a mortgage that’s going to end in foreclosure. But, with the help of professionals, it’s much less daunting. That’s where pre-approval comes in! How can you start looking at homes without knowing how much you can afford? (Hint: you can’t). So…what is pre-approval?
Pre-approval is the process in which a lender gives you a written statement of their very first determination of how much money you would qualify for (under that lender’s guidelines).
This determination/mortgage amount are determined by your income and credit information (I hope you paid attention on day 1!). Most preapproval letters stand for 60-90 days, giving you the ability to securely say “I can afford this much”. Then, you can look at houses within that price range without worrying about whether or not you can afford them, because you already know!
Ahhhhhh…. (deep breaths, people)