A friend of mine I met in college told me his school had a class that taught, for the lack of a better phrase, life skill math. It was a class that was not required, but heavily pushed, that taught math in the context of adult responsibilities. How much money will I have left to spend on groceries and luxury items after the monthly bills are paid? What do I owe out of pocket if Blue Cross is my primary insurance on this in-patient visit? But most importantly, an entire section was devoted to the intricacies of a mortgage loan, what it entailed, how to shop around for it, and how to balance monthly payments into your budget.
Flash back to me in high school; I had just signed up for Advanced Science Fiction, debating between a year-long piano class or a year-long culinary arts class, and had just finished taking the holy grail of physical education classes, combination racquets. While I was busy enjoying a semester full of racquet ball, tennis and badminton (and trust me, I did), others were learning valuable things to help them become homeowners in the future. Now I’m 23, and as I get closer to owning a home, I wish I had a firmer grasp on the intricacies of mortgages instead of a tennis racquet.
When I first began studying the whole mortgage process I tackled the beast head on. FHA? Sure I know what that means. HARP? Okay, maybe slow down with these acronyms. VA loan? Alright, I need help. It’s one thing to learn something completely foreign to you, but there’s anxiety-fueled pressure when you have a lot to learn about an extremely important financial decision. There’s got to be others out there in my age group and situation that are completely green to the mortgage process, and need it broken down in the simplest of terms.
So here, after my crash course in everything mortgage related, I present to you the mortgage process in the most palatable way possible. Now, because these are simplified answers, don’t go to your nearest mortgage banker quoting me. There are tons of options and variables that can change your loan that cannot be explained simply, so make sure you do your research beyond this if you’re attempting to purchase a home or refinance.
What is a mortgage?
A mortgage is very much a loan; in fact, it’s often called a mortgage loan because it is the physical legal document in which property (your house, most likely) serves as collateral for your repayment of a loan. According to the almighty Wikipedia, in French law, mortgage translates into the overdramatic “death contract.” Don’t be scared though, they call it that because there is no way out of a mortgage unless the property owner dies or if he/she can’t afford to keep paying the mortgage. If that happens, the property is foreclosed on, or taken by the mortgage company, as a result of incomplete payment.
Okay, so what are these monthly payments about?
When you go to buy a house, you make an initial down payment and start to make monthly payments on the whole loan based on an interest rate. The good news is interest rates are lower now than they have been in 40 years, and ultimately these rates are determined by lots of different factors including:
Inflation – You remember your grandparents saying “In my day we would pay five cents for a gallon of milk!” That’s because of inflation; it’s not that things have gotten more expensive, it’s that the money we’re using is worth less. When inflation makes the US dollar less in value, it devalues everything that is denominated by the US dollar, including mortgage backed bonds. Generally, if inflation rises, so will the demand, and eventually the prices for homes and mortgage rates.
Federal Funds Rate – The Federal Funds Rate, which is influenced by the Federal Reserve, is an interest rate between banks making loans, and can affect mortgage interest rates. When the FFR is raised, borrowing is more expensive and lowers the amount of money available overall; this can lower or suspend inflation. The opposite works too: lowered rates on banks means more borrowing which means higher inflation. The Fed can also use stimulus packages to move the mortgage rates where deem it necessary, and their economic projections can influence the rise or fall of mortgage rates.
Your finances – Many factors unique to you can affect your finances and subsequently your interest rate. Your monthly income, debt, bills, credit score, and history play into what you’ll qualify for. For example, you could have a high monthly income but lots of student loans and get a higher interest rate because of it. There are lots of variables here that can affect your interest rate.
Umm, so how do I know if I can afford this?
Do your homework and make sure you can afford any interest rate you may be locked into, with money to spare. But a good way to see where you’re at on the road to home ownership is to use a mortgage calculator to see if you can responsibly handle a monthly mortgage payment. Quicken Loans has a free one, wink wink, that will help you with purchasing, refinancing and amortization.
This is just the tip of the mortgage iceberg, but hopefully it gave you a firmer grasp on mortgage rates and how they determine your monthly payment. What other questions do you have about the mortgage process?