9 Factors To Consider Before Taking Out a Mortgage
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If you want to own a home, you likely need to borrow money to make it happen. That’s where a mortgage can help. A mortgage loan is a type of financing offered by lenders to help you buy a home. Taking out a loan to buy a home is common. In fact, mortgage debt is the highest when compared to other types of debt and stood at $12.14 trillion as of Q3 2023, according to the Household Debt and Credit Report by the Federal Reserve Bank of New York. Here’s what you should know before buying a new home.
9 factors to consider with a mortgage
A mortgage is a type of loan. In exchange for the loan, you’ll pay interest and make monthly payments for between 15 and 30 years until your mortgage is paid off. If you fail to make mortgage payments, the lender has the right to seize the property. In other words, taking out a mortgage is a big commitment and there are many factors to consider.
1. Types of mortgages
There are different types of mortgages that you may qualify for and it’s important to understand the differences. Some common types are:
- Conventional mortgages: This is a standard mortgage offered by lenders. Each lender may have different requirements for credit scores and down payment. If you have a 20% down payment, you can avoid paying Private Mortgage Insurance or PMI.
- Government-backed loans: The Federal Housing Administration (FHA), Veterans Affairs (VA), and the United States Department of Agriculture (USDA) offer government-backed loans (meaning the government insures the loan) to eligible applicants. If you qualify, there can be attractive terms. For example, FHA loans allow you to pay 3.5% down and will accept credit scores of 580 and above. VA loans for veterans allow you to purchase with 0% down and may have more competitive interest rates.
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2. Down payment
As part of the homebuying process, you’ll likely need to provide a down payment. A down payment is a percentage of the home price that you pay upfront.
Typical down payments are between 3% and 20%. Just remember, that for conventional mortgages, if you put down less than 20% as a down payment, you’ll be required to get Private Mortgage Insurance.
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3. Mortgage term
Your mortgage term is the length of time you have to repay your loan in full. Most people choose a 30-year term, though there are 15 and 20-year terms. The term you choose will determine the size of your monthly payments.
The longer you have, the less you’ll pay per month — but you’ll pay more in interest. A shorter term can lead to interest savings but also higher monthly payments.
4. Mortgage rates
Another major factor that will determine your monthly payments is your mortgage rate. Mortgage rates are currently high — at least compared to the rock-bottom mortgage rates at the beginning of the pandemic.
For example, mortgage rates were above 7% for several months toward the end of 2023. In March 2020, mortgage rates were half that at 3.5%. Using a mortgage loan calculator, you can see what the difference in monthly payments is with these different rates.
For example, a $300,000 home with 20% down, a 30-year term, and at 3.5% has a monthly payment of $1,341. Keeping the same variables but doubling the mortgage rate to 7% increases the monthly payment to $1,860 per month.
Also, your payment depends on the type of interest rate on your mortgage. You can have a fixed rate that remains the same, offering predictability for budgeting. There are also adjustable-rate mortgages with mortgage rates that start out fixed but then become variable and may change based on economic and market conditions.
5. Mortgage rates predictions
There’s been a buzz about high mortgage rates this past year and how they’re affecting homebuyers’ budgets and payments. No one knows what the future holds, but the National Association of Realtors (NAR) made some mortgage rates predictions forecasting a drop in interest rates for 2024.
6. Monthly costs
Your monthly mortgage payment is a major factor in your personal budget and financial well-being. The size of the payment is based on several factors including the down payment, loan amount, interest rate, and loan term.
Review how much you can afford while maintaining your other financial goals, such as paying down debt, saving, and investing. You may qualify for a mortgage with a higher monthly payment, but it’s a good idea to be conservative so you have some breathing room in your budget.
Your monthly mortgage payment generally consists of four components:
- Mortgage principal
- Interest
- Taxes
- Insurance
Keeping your monthly costs affordable relative to your income can help you save for any unexpected costs that arise with homeownership (like a roof leak or a pipe bursting). Plus, you may have extra room in your budget for renovations or picking out your dream furniture to make the place your own.
7. Debt-to-income (DTI) ratio
Your debt-to-income (DTI) ratio is considered as part of the eligibility requirements for a mortgage. DTI is a metric that looks at how much money is going toward debt payments, compared to your overall income.
A DTI of 36% or less for all debt is recommended for homeowners by the Consumer Financial Protection Bureau (CFPB), though some mortgage lenders may allow up to 43%. The CFPB recommends a mortgage-only debt-to-income ratio between 28% and 35%.
8. Closing costs
There are also closing costs or additional fees that are paid when everything is finalized. According to the CFPB, Some fees can include:
- Origination fees
- Appraisal fees
- Credit report costs
- Title insurance fees
- Lender fees
9. Foreclosure
Since a mortgage is a loan that is tied to an asset like a home, if you fail to make payments, your property can be seized by the lender. This process is called foreclosure. Typically, you’ll be notified about a foreclosure, and you may or may not need to go to court based on state law.
To avoid this happening, talk to a housing counselor who can advise you on the next steps if you’re struggling with mortgage payments.
Managing mortgage payments
Depending on your situation and goals, there are various ways to manage mortgage payments.
- Mortgage refinancing: Once mortgage rates drop, you may consider mortgage refinancing. Through a mortgage refinance, you typically apply for a new loan to score a lower interest rate or payment. The loan will pay off your current mortgage and then you’ll pay the refinance loan. Though you may save on interest or payments, you still typically have to pay fees and closing costs. You can use a specific mortgage loan calculator to review how refinancing would affect payments and total costs.
- Pay off the mortgage: If you want to be mortgage debt-free ASAP, you have the option to pay off your mortgage faster than your repayment term. If you make extra payments, discuss with your lender so that they put them toward the principal balance. Before going this route, check if there are any prepayment penalties.
- Selling the home: If you realize you can’t afford mortgage payments or want to move elsewhere or go back to renting, you always have the option to sell your home. Before making this decision, review how much you still have on your mortgage versus how much your home is worth. If your home isn’t worth as much as your loan, your home is “underwater.”
Whatever decisions you make regarding buying a home, make sure to do your due diligence and review the numbers. Check out mortgage rates, use a mortgage loan calculator, and look at your budget before making the biggest purchase of your life.
