Mortgage 101: Our Guide To Mortgage Basics

Buying a home is exciting and comes with all sorts of choices: location, house style, furniture and more. Aside from figuring out what neighborhood you want to live in and the type of house you want, it’s also important to learn about mortgages to help you make the best decision for your future.

To help you out, we’ve created a mortgage 101 guide so that you’re confident when you begin the application process.

Understanding Mortgages 

Unless you buy a house with cash, you’ll need a mortgage. A mortgage is a secured loan, using the home you purchased as collateral. That means you sign an agreement promising to pay back the lender – typically in monthly installments – over an agreed-upon term. If you don’t pay your mortgage, you will be at risk of going into default and the lender can foreclose on your home and sell it to recoup their investment.

Types Of Mortgages

There are several different types of home loans. The mortgage that you qualify for will depend on an array of factors, including your credit score, down payment and the location and cost of the property you choose. The mortgage options that you come across on your home buying journey will typically include:

• Conventional mortgages: A conventional home loan is one of the more popular types of home loans. A conventional loan is a type of mortgage that isn’t formally backed by a government agency – instead, it follows guidelines such as income and down payment requirements set by Fannie Mae and Freddie Mac.
• Fixed-rate mortgages: A fixed-rate mortgage is the home loan option with an interest rate that stays the same the entire time you’re paying it. This type of mortgage rate means you’ll have a fixed payment throughout the life of your loan unless you refinance or alter your loan in another way.
• Adjustable-rate mortgages: An adjustable-rate mortgage (ARM) is a home loan that has a set interest rate during the introductory period of your loan, then adjusts according to current rates. An ARM usually offers introductory rates that are lower than what you’d get with a standard fixed-rate mortgage; however, once the introductory period is up, your rate might go up.

Rocket Mortgage^® no longer offers 5/1, 7/1 or 10/1 adjustable-rate mortgages, but does offer 5/6, 7/6 and 10/6 ARMs. These ARMs adjust every 6 months after the introductory period is over. Let’s get into what those numbers mean. The first number indicates how many years the introductory period lasts, and the second represents how often the rate gets adjusted after the introductory period is over. For example, 5/1 means the introductory period is 5 years, and the 6 means the interest rate adjusts every 6 months after the period is up.

• FHA loans: An FHA loan is a Federal Housing Administration-backed mortgage, which is one of the few things that separates it from a conventional loan. FHA loans tend to have lower down-payment requirements, as well as less-stringent credit requirements. This is the perfect mortgage for low- to moderate-income families looking to purchase a home.
• USDA loans: If you are purchasing a home in a rural or suburban part of the country, you may qualify for a USDA loan. This type of mortgage is backed by The U.S. Department of Agriculture and offers financing options for families with low or moderate incomes. Rocket Mortgage does not offer USDA loans at this time.
• VA loans: A VA loan is a mortgage backed by the Department of Veterans Affairs. These loans are made specifically for veterans as a thank you for their service and can provide borrowers with better loan terms than they could get otherwise.
• Jumbo loans: A jumbo loan is a bit different from a conventional loan because it is a mortgage for an amount larger than the limits set by Fannie Mae and Freddie Mac. If you are looking to purchase a home that exceeds the conventional loan limit, this type of loan might be for you. Jumbo loans typically have higher interest rates and stricter requirements.

Mortgage 101 Basics: Key Terms To Understand 

Now that you are familiar with the different types of home loans, it is important you learn the basic key terms in the home buying process.

Here are a few to look for:

• Preapproval or prequalification: Though these terms are used interchangeably, they're actually different. Prequalification means that you've given the lender some basic information, like income and current debt, and they've done some initial calculations about how much you can afford. Preapproval, on the other hand, means that the lender has asked looked into your financial profile in more depth, and has determined you are a well-qualified buyer. When you are preapproved for a loan, you are approved for a set amount based on the information you provide, but variances may arise depending on how large your down payment is and what the property appraises for.
• APR: An annual percentage rate (APR) is the “true cost” of what you’ll need to pay the lender for taking out a mortgage, including the interest rate and any additional fees. Essentially, an APR is the yearly rate charged for a loan.
• Interest rate: An interest rate is the amount your lender charges you to borrow money used for your mortgage. It does not include any other charges associated with the mortgage loan, and it is expressed as a percentage.
• Escrow: This is money that’s held by a neutral third party that handles funds for home buyers and sellers. This is where you could put your earnest money, your homeowners insurance or property taxes.
• Earnest money: This is money, usually 3% – 5% of the home’s cost, you need to put down to show you’re serious about purchasing the home. The cash is held in escrow until you get your mortgage approved and the seller keeps it in many cases if the sale falls through.
• Mortgage points: This is a fee you pay upfront to help lower your interest rate. One point usually lowers your interest rate by 1%, depending on the lender.
• Underwriting: Underwriting is part of the mortgage process during which  the lender reviews your loan to determine whether it should be approved.
• Equity: Equity is the amount of your home that you own. It can be calculated by taking the current value of your home and subtracting it from what you still owe (aka your loan balance).
• Closing costs: A closing cost is the amount you’ll need pay to close on your mortgage. It’s sometimes referred to as settlement costs, and it is different than a down payment. Keep in mind that the seller is allowed to pay the closing costs for you, which is something you should consider negotiating before purchasing a home. Consult your real estate agent to decide if your current market is a good place to negotiate this, as it’s not always the best strategy in a seller’s market.
• Prepayment penalty: As the name suggests, a prepayment penalty is a fee you’ll be charged if you make extra payments on your mortgage or pay it off early. Not all lenders charge a prepayment penalty, so be sure to ask about this when shopping for a lender.
• Loan estimate: A loan estimate is a document that breaks down your home loan, including interest rate, APR, estimated monthly payments, insurance, taxes and closing costs. A lender will send this document to you at least 3 business days before closing.
• Principal: Principal is the actual amount you borrowed. It does not include extra fees, like interest rates and closing costs.
• Mortgage lender: A mortgage lender is the bank or company that offers and underwrites loans.  
• PMI: Private mortgage insurance (PMI) is typically required when you have a conventional loan and a down payment of less than 20%. It is insurance that protects the mortgage lender if you stop making payments on your mortgage. It is arranged by your mortgage lender and provided by private insurance companies. You might have to pay a monthly premium or an upfront premium, depending on the lender’s requirements.
• Loan term: The terms and conditions associated with repaying a home loan is the loan term. This can include the repayment period, cost of monthly payments, interest rates and APR.  
• Loan officer: A loan officer underwrites loans to determine whether a person qualifies for a home loan.

An Overview Of The Mortgage Process

Although the details may differ depending on your lender and your financial situation, here’s a general breakdown of the mortgage process:

Preapproval Or Prequalification

As stated before, preapproval and prequalification are different. If you are prequalified for a loan, you’ve probably provided a lender with basic information like your age and debt-to-income ratio (DTI). The lender then does some basic calculations to determine how much you could afford based on average numbers from people with similar demographics as yourself. Just because you’ve been prequalified for a loan does not mean you will be approved, it’s just an estimate for you to work from.

If you are preapproved for a loan, a lender likely has looked at more extensive details like your credit score, age, income, DTI and the down payment amount you can commit to putting down, and they’ve determined that you are a well-qualified buyer. The lender will use the mortgage preapproval documents that you provided and preapprove you for a loan based off those numbers. This means that the lender will approve you for a home loan amount, but the final numbers, like the monthly mortgage payment and interest rate, may change before closing based on your down payment, credit history and other factors.

House Hunting

Deciding which home is right for your family comes with a host of factors, including location, schools and jobs in the area, square footage, amenities and cost. Finding and eventually buying a home can be overwhelming, so it’s suggested that you work with a real estate agent to help you find the perfect home for your family.

Mortgage Application

In this step, you’ll officially apply for a mortgage by submitting more personal information and agreeing to a hard credit inquiry. This could impact your credit score in the short term, but your score should rebound after you start making consistent payments on your new debt. Once you submit your mortgage application, your loan will go through processing and underwriting.

Loan Processing And Underwriting

When you are getting a mortgage, a loan processor, or mortgage processor, will assemble, administrate and process your loan application paperwork. This is the step where you’ll need a home appraisal to determine the property’s value – a lender will not extend a mortgage loan for more than the property is worth. Your documents will then be sent over to an underwriter, who is responsible for approving or denying your application. Underwriters do not set interest rates, but they do determine if you are a high or low risk buyer.

Closing

When it’s time to close on a home, it’s time to put a predetermined amount of money in your loan estimate into escrow. Closing is simple:

Step 1: Pay the closing costs

Step 2: Sign all the required documents

Step 3: Wipe your brow and take a deep breath. Your hard work has paid off, and the home is yours.

Mortgage FAQs

If you still need more mortgage 101 facts, here are a few frequently asked questions you may come across on your home buying journey.

How long does it take to process a mortgage?

Since the whole mortgage process has many morning parts, it can take a while for everything to be done. This includes everything from preapproval, to getting a home appraisal, to the underwriting process. Typically, it can take around 30 days from when you officially apply for your mortgage to when you get your home loan. However, during busier times of the year, it can take an average of 45 – 60 days.

What is included in a mortgage payment? 

Principal, interest, taxes and insurance are included in mortgage payments. Fees that are not included in your mortgage payments include utilities and homeowner association fees (if you have an HOA).

What’s the difference between a loan and a mortgage?

A mortgage is a type of loan, but it is different from a personal loan. A mortgage (or home loan) is a secured loan, meaning it uses your house as collateral. If you stop making payments on your mortgage, the loan could go into default and the lender can foreclose on the home and take it back. A mortgage is restricted to real estate purchases only.

A personal loan is not restricted to real estate and can help finance various purchases or expenses for borrowers. When you take out a loan, you receive money in exchange for future repayments of its value – the principal amount – along with any interest or finance charges. Personal loans are typically unsecured loans.

How can I get approved for a mortgage?

In order to be approved for a mortgage, lenders will consider different things to determine what type of home loan you qualify for. Usually, factors like income, debt, credit score and down payment amount will be the key to whether you are approved or denied for a home loan. However, the cost and location of the home that you would like to purchase will make a difference as well, especially if you are looking to get a USDA or jumbo loan. Each loan type has its own set of requirements, so it’s important to connect with a real estate agent and lender to determine which loan best suits your situation.

The Bottom Line

Tackling mortgages can be a tricky task, but it can be made simple with a little research and the right tools. We hope this guide has provided you with enough mortgage information that you feel confident starting this new journey. If you’re ready to start the home buying process, Rocket Mortgage is here to help. Apply today.