So you’ve found the perfect home. Now all you need to do is actually get the money together to buy it. As houses cost several times the average annual salary, you will almost certainly need to get a loan, or mortgage. A mortgage is a special type of loan which allows a lender to repossess the underlying asset if the borrower does not keep to the loan agreement, usually by defaulting on agreed payments. This means that lenders are prepared to lend higher sums at lower interest rates than they otherwise would.
There are three things you really should consider when taking out the mortgage, the amortization period, the interest rate and the down payment.
The amortization period is the amount of time it will take a borrower to pay off the entire mortgage. It assumes that all mortgage payments are made according to the initial mortgage payment schedule, no additional payments are made and that the interest rate is predictable (usually staying the same). Most mortgage amortization periods are 25 years, and the longer your amortization period the lower your monthly payments will be while at the same time the higher your overall repayment will be. Amortization periods can be up to forty years.
Interest rates can be fixed, variable or adjustable. A fixed rate will not change for a certain period. Variable rate deals mean that the interest rate increases or decreases according to market conditions. Adjustable rate mortgages have the mortgage payment as well as the interest rate changing along with the market.
Essentially an adjustable rate is the least risky for the lender as they can match your payments to the payments that they make to their depositors. A fixed rate is the most risky as it could be making a serious loss for a lender that has to depositors higher rates in a few years. This means that the more uncertainty that the borrower takes on the cheaper the deal will be. So a long fixed term (six years is about the longest) will be quite a bit more expensive than an adjustable mortgage.
However there are two reasons for taking a fixed mortgage. The first is that you believe that interest rates are likely to increase over the term. If this is the case then you will lock in the lower rate. You will also be locking in a higher rate if the rates go down. The second reason is if you want the certainty of fixed costs. Variable rates will give you the certainty of fixed payments, although the interest could accrue.
The Down Payment
Few mortgage companies will lend you money to buy a house if you bring no money in. This money is called the down payment. A down payment means that you are invested in to the purchase, that you have the discipline to save and that if you were to default that there is less risk that the mortgage company will be left with an asset that is worth less than the money they have advanced. If you have a down payment of less than 20% then you will have to get mortgage insurance. This protects the lender from the consequences of you defaulting and can be thousands of dollars over the term of the mortgage. In some cases lenders, especially after the credit crunch, will insist that you take out mortgage insurance on larger deposits.
The amount of down payment that you make can have a big effect on the terms you are offered. The best interest rates can be reserved for the lower down payments, as these are seen as less risky by some lenders. A variation on down payments are open mortgages, which allow a borrower to pay down the mortgage if they get some money later on. This will of course reduce the interest. Open mortgages tend to be more expensive.
Other factors in your mortgage
There can be other factors that are beyond your control that can affect the terms that you are offered.
Credit history - Some lenders are wary of lending to anyone with a poor credit rating or credit history due to a perceived increase in the risk of default
Age – Longer amortization periods may not be available to people who are likely to retire before the term is out.
Job status – If you are self employed getting a mortgage can be hard. Government jobs, which are seen as more secure, can attract particularly advantageous deals
Type of property – Lenders may not offer certain terms on certain properties.