How does a mortgage loan work?
You've been scrolling online listings, strolling cool neighborhoods and hitting open houses. Then boom—you see a home that has your name all over it. Like most of us mere mortals, you can't throw down the full payment in cash. This is where a mortgage steps in to help.
What is a mortgage loan?
A mortgage is a specific type of loan that helps you cover the cost of buying property. You'll borrow money from a lender and pay it back over time with interest and, in the meantime, you get to settle in and make the place your own.
Who are the parties involved in a mortgage?
A mortgage on a house is a pretty hefty loan, likely one of the biggest you’ll 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’re good for the money—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: Got a sidekick? A co-borrower is someone who jumps in alongside the primary borrower to apply for the mortgage. This is often a spouse, partner or perhaps a close family member who's willing to share the responsibility of paying back the loan. If the co-borrower has 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.
What’s included in a mortgage payment?
Probably more than you imagined—a mortgage payment is broken down into a variety of costs, like the:
- 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” 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. For some FHA loans, MIP lasts for the loan duration, but for others, it ends once 20% home equity is achieved.
- Private mortgage insurance (PMI): This may be required if you put less than 20% down on your house. It protects the lender in case you default on your loan.
- Taxes and insurance: These go into an escrow account (kind of like a safety deposit box) to cover taxes and 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. Now let’s get into specifics:
- 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.
PRO TIP
When choosing a mortgage, consider if there are any penalties for early repayment. Many homeowners aim to pay off their mortgage early by making extra payments regularly or when they come into extra money. Always verify that you won't incur extra fees for achieving your financial goals ahead of schedule.
Types of mortgage loans
When it comes to mortgages, there are lots of loan options to choose from. Every type of mortgage comes with pros and cons, so be sure to fully assess your situation when choosing the right one for you. When in doubt, ask your lender for advice.
Here’s the scoop on a variety of mortgage options:
Institutional lender loans
Banks and other private financial entities, such as Citi, offer mortgage programs that feature lenient requirements and lower expenses for first-time home buyers. For instance, Citi's HomeRun® Mortgage is a unique program that requires a minimal down payment and helps people from various financial backgrounds purchase their first 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 purchased 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, they're great for first-time home buyers or anyone who's had a few financial hiccups. With lower down payments and a more forgiving outlook on credit mishaps, FHA loans feel a bit like a financial wingman.
- VA loans: Brought to you by the U.S. Department of Veterans Affairs, these loans benefit veterans, active service members and surviving spouses. With perks like no down payment (for those with 100% of their loan guarantee benefit) and no private mortgage insurance, they’re a way of saying “thank you” with extra help on the home front.
- USDA loans: Buyers in rural areas can get a leg up in the mortgage game. With 100% financing, there’s no requirement to save for a down payment. And thanks to reduced mortgage insurance and interest rates, long-term expenses are lower as well.
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, luxury 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:
| Feature | Non-Conforming Jumbo Loan | Agency Jumbo Loan |
|---|---|---|
| Backing | Private lenders (no government backing) | Supported by government agencies (Fannie Mae, Freddie Mac) |
| Loan Limits | Exceeds the standard limits set by FHFA | Exceeds standard limits, but within higher limits for high-cost areas |
| Guidelines | Vary by lender; more flexible, but stricter qualifications | Uniform and strict, adhering to government agency guidelines |
| Interest Rates | Generally higher due to increased risk | Typically lower due to government backing |
| Risk and Security | Higher risk for lenders; more stringent borrower qualifications | Less risky due to government support; more secure for borrowers |
| Flexibility | More flexibility in loan amounts and underwriting | Less flexibility, must meet specific criteria |
How to qualify for a mortgage
So, what does taking out a mortgage mean? Here are some of the stages along the way:
- Using our Affordability Calculator
Start by crunching some numbers to see how much house you can afford. If you're in tip-top shape, move on to step two. If your credit score or savings account need some attention, no sweat. Now you have a clear goal to work toward. - Getting preapproved
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 preapproval can help you stand out from the crowd. - Getting 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. - Closing 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.
How are interest rates set by lenders?
Interest rates can be a fickle beast—they may fluctuate often and be swayed by a mix of factors. These include broader market conditions, which are often out of your control, as well as specific aspects of your loan and property. The type of loan you choose, your credit score, your location, the type of property, the purpose of the loan and the loan-to-value ratio all play a role in determining your interest rate.
Luckily, you can set yourself up for success. Upping that credit score and decreasing your debt-to-income ratio can help you score better loan terms. If interest rates happen to drop, 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.
Fixed-rate vs. adjustable-rate mortgages
Here are two types of mortgage interest rates you're sure to encounter:
- Fixed-rate mortgage: This is the “Steady Eddie” of mortgages, meaning your interest rate 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 but 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, it's worth considering.
Mortgage terms defined
As promised, here are some handy definitions of common real estate terms:
| Term | Definition | |
|---|---|---|
| Amortization | Consider this your journey to owning your home outright. Each payment you make takes you one step closer to full ownership, unlike rent payments that never come back. | |
| Down Payment | This upfront chunk of cash helps you secure a loan. It’s where saving pays off because the bigger the down payment, the smaller the loan. Not quite there yet? Explore FHA loans or ask your lender for ideas. | |
| Escrow | These special accounts hang on to your tax and insurance funds so they’re safe until needed. It’s much easier than saving money you'd be tempted to spend––and that’s the point. | |
| Interest Rate | Nobody’s favorite fee, interest is the percentage of extra money you’ll have to pay in order to borrow from the bank. Yeah, it's a bit of a bummer, but interest payments are part and parcel of a mortgage. | |
| Mortgage Note | These important (and very dry) contracts spell out all the details of your loan. While you may not understand every last word, be sure to read it carefully so you know exactly what you’re signing up for. If you get tripped up on legal jargon, your lender will be happy to translate. | |
| Loan Servicer | You’ll know them on a first-name basis because once your loan is finalized, they’ll be your primary point of contact. They’ll collect your monthly payments, manage your escrow account and answer any questions you might have. |
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.
