What is a mortgage? Understanding home loans

Browsing online real estate listings is fun, but what if you see your dream home and want to do something about it? Most of us can’t afford to buy an entire house with cash. That’s where a mortgage comes in.

What is a mortgage loan?

A mortgage is a specific type of loan that helps you cover the cost of buying property. With a mortgage, like other loans, you borrow money from a lender and pay it back over time with interest. In the meantime, you get to settle in and make the place your home.

A mortgage loan might be one of the biggest loans you ever take out. There’s more to it than simply handing the seller a check. There are safety measures involved to protect all major players, including the:

• Mortgage lender: This is the financial institution that lends you money and ultimately determines your interest rate. A bank, like Citi, or a mortgage company will act as your lender. They’ll just need to make sure you can manage the payments—but more on that in a bit.
• Borrower: You’re the star of this show, and you’re making a promise to pay back the loan over time. It’s a big responsibility, sure, but it’s how most Americans break into homeownership.
• Co-borrower: A co-borrower is someone who jumps in alongside the primary borrower to apply for the mortgage. It might be a spouse, partner or perhaps a close family member who’s willing to share the responsibility of paying back the loan. If both you and the co-borrower have a solid credit score and a steady income, it can lead to better loan terms or a bigger loan amount, which may help you afford a pricier home.

Citi’s online mortgage application process makes it easy to add a co-borrower and explore the best loan options for you before making a decision.

A mortgage payment is broken down into several costs. Depending on factors like your down payment amount and where the home’s located, your payment may include:

• Principal: This part goes toward paying back the amount you borrowed. You can chip away at it slowly, like most homeowners do, or make additional payments to reach “paid in full” status a bit faster.
• Interest: Consider this the cost of borrowing money. It’s the extra amount you pay the lender for giving you a loan.
• Mortgage insurance premium (MIP): This comes into play for certain mortgages, especially with a Federal Housing Administration (FHA) loan. It requires an upfront fee and annual payments, typically divided into monthly installments. The cost depends on the loan amount, term and loan-to-value ratio. If you put down less than 10% on an FHA loan, MIP lasts for the loan duration. With a down payment of 10% or more, MIP can be removed after 11 years.
• Private mortgage insurance (PMI): This may be required if you make less than a 20% down payment. It protects the lender in case you default on your loan.
• Taxes and insurance: You’ll generally put funds into an escrow account (kind of like a safety deposit box) to cover property taxes and homeowners insurance. With some loans and lenders, you can choose to forgo escrow as part of your monthly mortgage payment and instead pay these fees directly.
  • Property taxes are tallied based on the assessed value of your home and are used to pay for things like schools, roads and public safety—pretty important. Tax rates can vary a lot depending on the cost of living in your area and may increase over time, so be sure to build these costs into your budget.
  • Homeowners insurance is essential. It protects you in case unexpected damage or theft occurs. The cost of this coverage depends on the value of your home, the level of protection you choose and your location.

When it comes to mortgages, there are lots of loan options to choose from. While most mortgages work more or less the same way, each may have different pros and cons, so be sure to fully assess your situation when choosing the right one for you.

These are some of the most common mortgage options:

Institutional lender loans

Banks and other private financial entities, such as Citi, offer mortgage programs that feature flexible eligibility requirements and lower expenses for first-time home buyers and experienced buyers alike. For instance, Citi's HomeRun® Mortgage is a unique program that requires a low down payment and helps people from various financial backgrounds purchase a home. Heads up: this program is available in select markets only and income limitations may apply.

Conventional conforming loans:

These loans conform to guidelines set by the Federal Housing Finance Agency (FHFA) and are eligible for purchase by Fannie Mae and Freddie Mac. They're popular because they usually cost less than non-conforming loans and work well for buyers with fairly solid financial histories.

Government-insured mortgages:

Similar to conventional loans, these mortgages are offered by institutional lenders and are insured or guaranteed by the government. Being government-backed translates to some pretty big benefits for borrowers. Here are some of the popular government-backed loan types:

• FHA loans: Backed by the FHA, these loans are great for first-time home buyers or those with a lower credit score. With lower down payments and flexible guidelines, FHA loans could be more accessible for eligible borrowers than conventional mortgages.
• VA loans: The U.S. Department of Veterans Affairs backs loans to benefit veterans, active service members and surviving spouses. With perks like no required down payment (for those with 100% of their loan guarantee benefit) and no private mortgage insurance, they’re a way of saying “thank you” on the home front.

Jumbo mortgages

When your real estate dreams outgrow that starter house, a jumbo loan might be just what you need. These loans exceed government limits and are designed for high-priced properties.

Now, there are two types of jumbo loans: non-conforming and agency. Non-conforming jumbo loans are larger, privately backed loans with flexible terms. Agency jumbo loans are also large, but they have government backing and are available only in areas where homes cost more, making them more uniform and generally cheaper. Let’s break it down:

Qualifying for a mortgage could be easier than you think. To get an idea of what you could afford, start by using our Affordability Calculator. If your credit score or savings account need some attention, no sweat. Now you have a clear goal to work toward.

When you know you can afford to buy a home, here are the next steps:

• Get pre-approved: This is an important step that shows sellers you mean business and have the financial backing to prove it. In a seller’s market, coming armed with pre-approval can help you stand out from the crowd. With Citi, you can apply to get pre-approved with our SureStart® Pre-Approval.
• Get final approval: When you’ve found a home and you’re ready to make an offer, your lender will finalize the details of your loan. This is yet another layer of security that shows the seller you’re in it to win it. Citi makes it easy to move from pre-approval into the final approval stages.
• Close on your loan: This is the grand finale where you sign the official papers, handle last-minute details and take hold of those precious house keys. Closing could be the longest part of the entire process if your search moved quickly.

Interest rates may fluctuate often and are determined by a mix of factors, including:

• Broad market conditions
• Type of loan
• Credit score
• Location
• Type of property
• Purpose of the loan
• Loan-to-value ratio

You can set yourself up to secure better loan terms by improving your credit score and decreasing your debt-to-income ratio. If interest rates happen to drop while you’re working on improving your financial profile, that’s a bonus, but at least you’ll know you’ve done everything in your power to secure a favorable rate.

Different loan options also come with varying interest rates based on their risk assessment and market position. It’s best to chat with a mortgage specialist to help you find a loan with the best interest rate for your unique financial situation.

Curious to see Citi’s latest interest rates? Check out today’s current rates to compare loan types. Then, you can plug different interest rates into the Mortgage Calculator to see the potential impact on your monthly payment.

Here are two types of mortgage interest rates you're sure to encounter:

• Fixed-rate mortgage: This is a home loan that has an interest rate that will stay the same for the entire life of your loan and your payments will always be predictable.
• Adjustable-rate mortgage (ARM): An option for those who are comfortable with change, this rate adjusts with the market. Rates may start out low for an initial period but will shift over time.

Mortgage terms: 15 vs. 30 years

• 30-year mortgage: This is the most popular option because it can keep monthly payments low by spreading out expenses over a longer period. However, it will end up costing more in interest.
• 15-year mortgage: By paying more each month, you’ll save on interest in the long run. It’s not for everyone, but if you’ve got the financial flexibility, a shorter loan term is worth considering.

As promised, here are some handy definitions of common real estate terms:

Learning everything there is to know about home buying is a lot, but you’re never really alone. From your local real estate agent to the lender you choose to work with, you’ll be surrounded by support from start to finish. Now get out there and stake your claim.