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Buying your first home can seem intimidating, especially when faced with many different loan types. When researching general information about the most popular home loan types, remember it is not as simple as finding the cheapest interest rate. At first taking out a mortgage may appear daunting, but once you break it down, it becomes straightforward. As with any financial decision, the first step in the process is to educate yourself about the process.

What IS a Mortgage?

What is a mortgage really? A mortgage is a lien on the real property that gives the lender the right to take the property by foreclosure if you default on the loan. Because most people cannot afford to buy real estate with cash, nearly every real estate transaction involves a mortgage. Contrary to popular belief, a mortgage is not a loan; it creates a lien on the property, which serves as a lender’s security for the debt. The party who borrows the money is the mortgagor; the party who provides the money is the mortgagee. A mortgage gives the lender the right to sell the secured property to recover funds if you do not pay the debt. .

While the choice of mortgage product affects the amount of the monthly mortgage payments, there are plenty of other aspects of homeownership, such as homeowner’s insurance, property taxes, maintenance, and homeowner’s dues, that need to be factored into your overall cost. The mortgage note, in which the borrower promises to repay the debt, sets out the terms of the transaction:

• The amount of the debt
• The mortgage due date
• The rate of interest
• The amount of monthly payments
• Whether the lender requires monthly payments to build a tax and insurance reserve
• Whether the loan may be repaid with larger or more frequent payments without a prepayment penalty
• Whether failing to make a payment or selling the property will entitle the lender to call the entire debt due

When comparing monthly payments from various lenders, be sure to ask if the lender included monthly taxes and insurance costs in the total payment. Often times if your downpayment is large enough, inclusion of taxes and insurance won’t be required, but you will instead pay your insurance company and real estate taxes directly.

It can not be emphasized enough that preparation is the key to ensure a smooth process. If you are working with a real estate attorney, he or she should walk you through the entire process in advance.

Pre-Qualified vs Pre-Approved

First, its important to understand the differences between a home mortgage prequalification and preapproval. Pre-Qualifying helps you determine what you can realistically afford in order to start your shopping. It provides an indication of what you expect to be qualified for. However, it is not a sure thing and doesn’t carry the same weight as being pre-approved. Home loan pre-approval is a more involved process, which includes submitting a formal application and documentation and provides a conditional commitment from the lender for the exact loan amount. Essentially you are getting your home loan approved prior to selecting a property. A pre-approval will require income and asset documentation. Pre-approval gives you a definite idea of what you can afford and shows sellers that you are serious about buying. A pre-approval can help you negotiate a better price with the seller, since being pre-approved is very close to having the cash to pay for the house.

Formal Application

Once you locate your property you wish to purchase and have a successful offer, it’s time to begin the formal application process. If you were not pre-approved, at this stage you will need to provide more detailed documentation to your lender, including assembling your financial records. Mortgage loan qualification guidelines typically differ depending on the loan program and the lender. The costs of your transaction may vary depending on the loan program you select with your lender, and any changes you decide upon during the loan process. The type of loan you choose is a very important aspect of the loan process, and one you should completely understand before making any kind of commitment. Once the lender receives all this information, they will verify them and start the decision making process. The appraisal is ordered and is done during the same time that the processor is verifying information. Whether it’s during the pre-approval stage or during the approval process itself, the essential question the lender’s underwriters are asking is “How good of a long term risk is the borrower?”

Approval

The loan processing (approval) stage is typically the longest in the process. During this step there isn’t really much you can do but wait. Again, be aware that any material changes in your financial situation can impact this stage, so before you do anything that could have an affect, make sure you discuss it with your lender. When the underwriter is satisfied, the borrower will receive an approval and be cleared to close.

As well as your home loan costs, there are other fees and charges associated with buying a property you need to consider, such as loan origination or underwriting fees, broker fees, transaction, settlement, and third party costs. Costs associated with property surveys and searches may be required. Make sure you look into the closing costs and other costs in detail. It is very important that each client fully understands all of the costs associated with their mortgage loan. Be aware that other fees and costs vary by program and by lender, so when you are shopping for a loan, make sure to get all of the associated costs so you can make a proper comparison.

Closing

The final step in the mortgage process is the closing meeting. You should have a good understanding of what is involved in the closing process, because there are a number of things that you can do to make sure that it goes smoothly and on time. The closing is a meeting, most often at the title insurance company, where the lender, homebuyer and seller meet to complete the sale and mortgage process. Closing costs may vary among companies and also throughout the nation because of differing local laws and customs.

A couple of fees to be aware of:

• Origination fee: This is the fee charged by a lender for processing a loan.
• Loan origination fee: Lenders charge these fees for processing of the mortgage agreement and other paperwork.

As with all the fees, rates, and points involved in a mortgage transaction, don’t shy away from negotiating these down or even out of the agreement. Keep in mind that knowing the process and having knowledge of the competitive marketplace enables you to be a more successful negotiator.

Parting Thoughts

With all of the finance programs available to the consumer, from conventional, adjustable rate mortgage and interest only, having an experienced mortgage professional on your side will help you achieve your goal of buying a home and should save you money in the process. Certainly your interest rate is important, but getting the right mortgage, receiving the true costs of the transaction, and getting sound counsel can be far more valuable than a fraction of a percentage difference in your rate. Improving your expertise and knowledge before you start will help the whole loan process be a smooth and relatively painless one.

A balloon mortgage is one in which monthly payments are made for a pre-determined period of time, with the balance of the loan paid in full at the end of the loan term. Like an ARM, interest rates on a balloon mortgage are typically lower than on a fixed rate mortgage and this makes the monthly payments on a this type of mortgage are very low and affordable. Balloon mortgage loans are calculated to amortize over a longer period than the due date of the balloon. A balloon, or lump sum, payment is required at the maturity of the loan to completely pay off the remaining principal. Therefore its important to keep in mind that the terms on a balloon mortgage are insufficient to completely amortize the loan.

Balloon mortgages can, and often do, contain a contractual opportunity to refinance at prevailing rates when the balloon payment is due. If the balloon mortgage loan has the option to be refinanced when the initial period expires, it will be called a convertible balloon mortgage. Some balloon mortgages come with “reset” clauses that provide for the original lender to reset the loan terms so that the loan is fully paid off in the remaining twenty three to twenty five years. The advantage of a balloon loan with a reset is that the loan payment will remain constant for the remaining life of the mortgage. The disadvantage is that the borrower is subject to the then current rates. If you are unable to convert or refinance the balloon mortgage, you may be forced to sell your home to make the loan whole. However, for the initial period of the loan, the interest rates on a balloon mortgage are usually a little lower than a comparable Adjustable Rate Mortgage.

Alternatively, with a fixed-rate mortgage you’ll have the benefit of knowing exactly what your monthly payments will be for the entire term of the loan. Because few people have the funds to fully pay off the balance due at the end of the balloon term, when using a balloon mortgage as the instrument of financing, the borrower should be concerned about future interest rates because they will be subject to them when the loan matures. However, most people that take out balloon mortgages assume that they’ll be moving within the term of the balloon period or that they will be eligible for a more attractive loan at the end of that period. Many people also use balloon mortgages to get that larger dream house. This strategy can, in fact, be fairly risky and a borrower should consider the market risk against the benefit of a larger home. Again, at the end of that period, the borrower must pay off the loan in full – this is the “balloon” payment. For example, a 7 year balloon calculated to amortize over 30 years will have low payments for 7 years and then the remaining balance will be due.

Before borrowing it’s important to consider whether you already have too much debt, whether you will be able to service the debt if you refinance at the end of the balloon period (or pay the balance), the risks associated with the current real estate market, and other factors as well. While it can be fairly easy to make the monthly payments on a balloon mortgage, it is very important to consider that there could be difficulty in managing the terms of the loan once it matures. In the current climate, fixed-rate mortgages are definitely the “loan of choice” for homeowners seeking a refinance mortgage, but if all the factors are considered and risks weighed, a balloon mortgage can be a viable alternative. Loan programs vary depending on the borrower’s credit, closing costs vary from state to state, work with your loan officer to get a proper estimate when you apply for your loan.

Amortization is a term associated with mortgage loans and is mainly used in relation to loan repayments. Technically defined, amortization is an accounting method in which expenses are accounted for over the useful life of the asset rather than at the time they are incurred. Amortization is similar to depreciation in that the value of the liability (or asset) is reduced over time. Simplified in terms of a mortgage, amortization is a payment each month that combines both interest and the principal amount and is paid over a specific period of time. The concept of amortization can seem complex and understanding the process is essential to becoming an informed borrower.

The simplest way to explain the difference between amortization and depreciation is understand the type of the financial events that they are associated with. Depreciation is a term used to define an asset (cash or non-cash) that loses value over time. Mortgage amortization is the periodic reduction of the principal balance of a home mortgage that is usually fixed in the terms of the loan.

For the purposes of a home mortgage, amortization is the reduction of the principal or capital on a loan over a specified time and at a specified interest rate. Interest is the fee paid by the borrower to reimburse the lender for the use of credit or currency. At the beginning of the amortization schedule a greater amount of the payment is applied to interest, while more money is applied to principal at the end. In other words, a borrower will start out paying mostly interest and in the end the majority of the monthly payment goes toward cutting down the actual loan amount.

A mortgage is amortized when it is repaid with periodic payments over a defined term. The goal is for the mortgage to be fully amortized, an elaborate way of saying paid off, at the end of the term of the loan. As more and more of the principal is paid down, the interest declines, leading to greater mortgage amortization in the later years of the loan and a subsequent increase in the borrower’s equity in the property.

One thing to consider when taking out a mortgage is the amount of money which will be paid out over the life of the loan. A mortgage calculator which provides an estimate of monthly payments and amortizations can make it easier to see the entire schedule and impact to the borrower. Negative amortization, which can occur in financing instruments like a balloon loan, exists when the monthly mortgage payment is not big enough to cover the full amount of interest due.

The process of amortization is an easy one to understand once you know the basics and get the idea of how it all works. Mortgage amortization, as used in real estate, is when the principal balance on a mortgage is reduced over time as the home owner makes monthly payments. Amortization describes the process of paying off a loan in regular, typically monthly, installments. As a general rule, amortization is desirable, because if a mortgage is not amortizing, it means that the borrower is not making any headway on the loan.

Escrow is a deposit, most typically of funds and/or documents, that is held until paid out upon successful completion of the terms of the escrow instructions. Technically defined, Escrow is a legal arrangement in which a neutral third party holds an asset during the period in which the conditions of the deal is being finalized by the other two parties. In actuality it can be money, property, or really any asset of (perceived) value. It can be used to transfer, or protect, personal and business property. While the property may be business assets, or intellectual property such as software source code, escrow is most commonly associated with real estate transactions.

In real estate, escrow provides a form of mediation between all the participants in the transaction; buyers, sellers, lenders, agents, and title company. The escrow is a holding place for all funds, instructions, and documents necessary for the purchase of the home, including the buyers funds for the down payment, the lender’s funds and documents for the new loan, and the sellers deed. When a buyer makes an offer on a property and the seller accepts the offer the buyer is expected to demonstrate the good faith of the offer with a cash deposit, also known as earnest money. In the event the conditions of the sale are met but the buyer decides not to go through with the deal, the cash deposit is typically given by the escrow agent to the seller as compensation for having taken the property off the market in anticipation of the purchase being completed. It is important that the escrow agreement carefully defines what does or does not constitute a release event and that it provides a process for providing notice of any events to the parties, the correct process for any response or objection to such notices, and the dispute resolution procedures.

Typically, an escrow begins with the Realtor delivering the purchase contract and the buyer’s earnest money deposit to the escrow company. The escrow company will prepare and deliver the initial escrow instructions and other related documentation. Once the purchase agreement has been executed, the purchase deposit made and an escrow account has been opened the buyer typically applies for a mortgage loan. Once the loan has been approved, the lender provides instructions detailing the conditions under which the funds can be disbursed. Bear in mind that the buyer must have the necessary insurance in place before most lenders will send the closing funds to the title company. Additionally, the lender may require that an escrow account to pay property tax and insurance during the term of the mortgage be established.

Closing costs associated with the transaction vary depending on the sales contract and may include items such as loan payoffs, inspections, any judgments or liens, recording fees, tax pro-rations, transfer taxes, notary fees and any other negotiated items. Real Estate commissions are traditionally paid at the close of escrow from the Seller’s proceeds. Another item settled during this transaction is title insurance, which insures the ownership of real property against any encumbrances to the title. If a buyer does not elect to buy title insurance, they are not protected, even if the prior owner had title insurance.

Once the new title has been recorded, the escrow agent prepares and delivers closing statements to both the buyer and seller. These statements should be reviewed in detail to ensure they are correct, and any inconsistencies within should be resolved before proceeding. Prior to closing, the buyer and the buyer’s agent do a final walk-through of the home to verify that contract terms are met.

When the terms of the purchase agreement are met, the escrow agent assigns the property title to the buyer and distributes the funds to the seller, records the deed, closes the escrow. An escrow account will provide the participants in the transaction with a guarantee that no funds or property will change hands until all of the terms and conditions have been followed to both parties satisfaction. The rules and procedures around escrow and closing can vary by region, title company, and lender. Therefore it is often advisable to engage an attorney familiar with the process. Ultimately, the use of escrow is intended to provide security and peace of mind for buyer, seller, lender and Realtor alike.