Mortgages are essential financial products - without them, the vast majority of people would not be able to buy a home. And yet, if they are so valuable, how come they can get so many people in trouble? From the Great Depression of the 1930s to the Great Recession of the 2000s, one of the signature traits of financial crises is the trail of foreclosed homes when people cannot keep up with their mortgage obligations.
Mortgages as a concept are neither good nor bad - the nature of any given loan depends on the details. Before you sign up for a home loan, there are a number of specifics you should understand.
9 must-know things about mortgage loans
Work your way through the following list, and make sure you are comfortable with each of these aspects of the loan before you commit:
1. Fixed vs. adjustable mortgage rates
Mortgages are available either with interest rates that are fixed throughout the entire term of the loan, or with rates that vary periodically. This makes a fundamental difference in the nature of your mortgage. With a fixed-rate mortgage, you know what your monthly payments will be over the life of the loan. With an adjustable rate, those payments are subject to variation. Adjustable rate mortgages allow you to benefit if interest rates fall, but they also put you at risk of no longer being able to afford your payments if interest rates rise.
2. Differences in lender interest rates
Besides knowing whether your mortgage rate is fixed or adjustable, you should also compare the interest rates offered by various lenders on similar loans because these do vary. Seemingly small differences can cost you greatly over the life of the mortgage, so shop around.
3. Cost of mortgage insurance
This is different from homeowners insurance. This is insurance that is required on certain loans, such as mortgages offered by the U.S. Federal Housing Administration (FHA), to protect the lender against the risk that the borrower will default. Your credit rating and the amount of your down payment can affect how much mortgage insurance will cost, so pay attention to what your options are. Understand whether you have to pay mortgage insurance over the life of the loan, or whether you are eligible to discontinue it once you have paid back a certain portion of the loan.
4. Estimated closing costs
In addition to your down payment and possibly a mortgage insurance premium, your lender might require you to pay points, which are an upfront percentage of the loan, at closing. On top of that, there are a variety of other fees that come in different forms from one lender to another. Your lender should be able to provide you with a written list of all the costs you will face at closing before you commit to the loan.
5. Loan-to-value ratio
This measures how much your loan represents as a percentage of the value of your home. The bigger the down payment you make, the lower your loan-to-value ratio will be, and that has a number of financial advantages. A lower loan-to-value ratio can:
- Reduce your interest rate
- Lower or even eliminate mortgage insurance premiums
- Increase your flexibility to refinance in the future
6. Length of mortgage loan term
This is how long it will take to repay the loan. Shorter terms typically mean higher monthly payments, but they can cost you much less over the life of the mortgage.
After knowing your interest rate and mortgage loan term, use a mortgage payment calculator to determine your expenses each month.
7. Mortgage payment schedule
Often, the best way to understand a loan is to look at the schedule of payments you will be required to make. Mortgage payment schedules show you:
- What the monthly burden on your budget will be
- Whether or not that number is subject to change
- How long it will take you to repay the loan
- How much interest you will pay over the life of the loan
8. Total vs. monthly mortgage costs
One thing you may notice when comparing payment schedules for different loans is that lower monthly payments don't always mean lower total costs in the long run. This is why you should consider both short-term and long-term costs when choosing a mortgage.
9. Possibility of prepayment penalty
Some loans make you pay a fee if you repay them early. This can limit your flexibility to refinance, so know whether your loan has such a fee, how much it is and whether it expires after a certain amount of time.
That's a lot of detail to review, but think about what is at stake. Your home is not only likely to be the biggest financial investment you ever make, but it is the roof over your head. If you are not ready to sweat the details, you may not want to make the commitment to home ownership.
More from MoneyRates.com: