Mortgages: A Complete Guide To How They Work

Mortgages: A Complete Guide To How They Work

Know your mortgage loan costs

Your principal and interest payment is only part of what you’ll pay. In most cases, your payment includes an escrow for property taxes and insurance. That means the mortgage company collects the money from you, holds onto it, and makes the appropriate payments when the time comes.

Lenders do that to protect themselves. Financial institutions want the first claim on selling your house if you fall behind on payments. If you don’t pay property taxes, the government will have a claim on some of the home’s value. That can make things complicated.

Mortgage lenders often make buyers who don’t make a 20% down payment pay for private mortgage insurance (PMI). This is insurance that helps the bank get its money if you can’t afford to pay. It doesn’t benefit you in any way.

If you can avoid PMI, do so. It can be hard to get a lender to remove it even if you have 20% equity. There’s no rule saying they have to and sometimes they will only if a new appraisal (an added cost to you) shows that you’ve hit that mark. You can also refinance when you get to 20%, but that can be expensive, as well.

The last cost to consider is closing costs. These are an array of taxes, fees, and other assorted payments. Your mortgage lender should provide you with a good-faith estimate of what your closing costs will be. It’s an estimate because costs change based on when you close.

Once you find a house and begin negotiating to purchase it, you can ask the current owner about property taxes, utility bills, and any homeowners association fees. Even if you get the actual bills, your numbers will vary. But it’s important to learn as much as you can about the real cost of owning the property.

Get a preapproval for your mortgage loan

Once you have a sense of your personal finances, you should know how much you can afford to spend. At that point, it may be time to get a preapproval from a mortgage lender. This is a letter from a lender that says, based on what it has seen, it would approve you for a mortgage.

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This isn’t a real approval, though it’s still important. It’s not as good as being a cash buyer, but it shows sellers that you have a good chance of being approved.

You don’t need to use the mortgage company that offered you a preapproval for your loan. This is just a tool to make any offers you make more attractive to sellers.

In a competitive market, sellers may get multiple offers. Being the highest offer helps, but that’s not the only factor a seller considers. The seller also wants to be confident that you’ll be able to get a loan and close the sale. A preapproval isn’t a guarantee of that, but it does mean it’s more likely. If you have a preapproval and someone else making an offer doesn’t, you may have your offer accepted over theirs.

Picking a mortgage lender

Mortgage lending is a crowded, competitive space. Because of that, don’t automatically go with the bank you have your checking account at or the lender your real estate agent suggests. Get multiple offers and see which lender offers the best rate, terms, and closing costs.

The easiest way to do that is to use an online service that brings back multiple offers or to use a broker who does the same. In some cases, a broker will know many of the companies making offers and can let you know which ones are easier to work with than others. 

If you have problems in your mortgage application — like a low credit score or a minimal down payment — a broker might help you find a sympathetic bank. In those cases, you may also want to talk to credit unions, especially if you’ve been a long-term member of one. They sometimes have looser standards than traditional banks do.

A good mortgage broker should be able to find out if you qualify for any government programs and explain to you which type of mortgage is best for you.

Find a home and seal the deal 

The last piece of the mortgage loan process is the home itself. Your lender can’t approve a loan without knowing the details of the house you plan to buy. Once you find a home, make an offer, and have your offer accepted, the approval process begins.

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This is where you’ll need all of the paperwork mentioned above. You’ll need your most-recent pay stubs. Let your employer know that your potential lender may contact the company to verify your employment, too.

The mortgage lender will also order an appraisal. An appraisal sets the value for the home in the eyes of the mortgage lender. It doesn’t matter what you’re planning to pay for the property. The important factor is the value the appraiser assigns. 

In recent years, appraisals have gotten more pessimistic. Lenders don’t want to loan you money they can’t recoup, so if the appraisal values the home below what you’re paying, your lender may want a larger down payment.

On top of the appraisal, you’ll also have a home inspection. This protects both you and the mortgage lender. In most cases, you’ll hire an inspector (though your lender or real estate agent can suggest one). Find someone with good reviews and accompany them while they inspect the property.

A good inspector will notice things you don’t. Maybe they see signs of past water damage or think the roof needs to be repaired. While the inspector is doing his or her work, you also want to check on some basic things:

  1. Turn on all the faucets and run them for a few minutes to make sure they drain.
  2. Do the same with the showers and tubs.
  3. Flush all the toilets.
  4. Make sure any included appliances work.
  5. Check to see that doors close and lock properly.
  6. Make sure that the garage door opens as it should.

That’s not an exhaustive list, and the inspector may check some of those things. Go into the inspection with a critical eye. If minor things are wrong, you may be able to get the current owner to fix them. When something major pops up, your mortgage lender may insist that changes are made or that the price is lowered.

You’re not looking to be a jerk here. The goal is to identify things that are truly wrong and address them. Don’t let your excitement about buying the home cause you to overlook things that should be repaired or replaced.

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Assuming you find a home and get it appraised and inspected, it’s time to close the loan.

Closing your mortgage loan

When you’ve found a home, placed it under contract, and received a mortgage commitment — a promise to lend you the money — from your lender, it’s time to close the loan. But there are a few things you need to do first.

Do a walk-through of the property once the current owner has moved out (or mostly moved out). Make sure any required repairs were completed and that no new damage was done during the move. It’s not fun to ask for compensation for damage or incomplete repairs at closing, but you should if something’s wrong.

Before the closing, check in with your lender to make sure you have everything that’s needed with you. You don’t want to get to the closing and learn that your lender wants to see a current pay stub or bank record.

It’s also very important to check over the closing statement. Your real estate agent can explain where it’s different from the estimate and why. In many cases, you’ll pay interest on the loan based on the number of days left in the month and you may have some other full or prorated charges.

Here’s the last thing: Don’t do anything before your closing that changes your financial situation. Don’t open a new credit card, buy a car, or spend a significant amount of money. You don’t want your credit score to fall or your lender to change its mind at the last minute. 

Once you close your mortgage loan — which generally involves a lot of signatures — it’s time to take a minute to congratulate yourself. Buying a home isn’t easy and it’s almost certainly the biggest purchase you’ll ever make. That deserves a bit of celebration — even if you still face the challenges of moving into and getting settled in your new home.

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