What do I need to understand about my mortgage?

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If you know anything about the “Great Recession” that began with the bursting of the housing bubble in 2008, then you know what evils can result when people and financial institutions recklessly create unrealistic mortgages. Make sure you know what you’re getting into with your mortgage and don’t take on more than you can handle.

First, it’s crucial to minimize your interest rate. A mere one-percent decrease can result in tens of thousands of dollars in savings over the life of your mortgage. To get the best interest rates, you will need to make sure your credit is in good shape. Before you even start looking, get a copy of your credit report and check it for errors. If your credit score is less than excellent, you should take measures to improve it before you consider taking on a mortgage (and our credit score page can help).

Once your credit is in order, you can decide on a mortgage lender. Be sure to shop around and compare rates and options to make sure you are getting the best rate and product for your situation. Obtain rates and information from several lenders—it could save you a lot of money in the long run. Click here for information on comparing mortgage products and rates.

There are different types of mortgages to consider when buying a home. A fixed rate mortgage has one set interest rate for the life of the loan, which is determined by prevailing lending rates at the time you originate the loan. Your monthly payments will also have little fluctuation, changing only in response to changes in your property taxes or insurance rates. When interest rates are low, the interest rate is likely to be higher on a fixed rate mortgage when compared to an adjustable rate mortgage, and vice versa. But don’t be fooled: that’s because prevailing interest rates will inevitably rise at some point, while the interest rate on your fixed rate mortgage will be steady. An adjustable rate mortgage (ARM) has an interest rate that can vary from year to year, tracking increases or decreases in prevailing lending rates. The starting rate offered for ARMs may be lower than that offered for fixed mortgages at any given time, but keep in mind that it could quickly become higher if interest rates rise (although there is often a limit to how much the rate can rise in one year, as well as a cap, or upper limit). ARMs are sometimes offered with an introductory “teaser” rate to entice borrowers. Read the fine print and understand the risks. There are also interest-only mortgages, where the borrower pays nothing towards the principal amount of the loan. If you can afford only an interest-only mortgage, you are probably trying to buy a more expensive house than you can afford. This type of mortgage is appropriate in exceptional circumstances. Click here to learn more. You may have heard of the subprime mortgage, which was a major culprit in the recent financial crisis. Subprime mortgages are offered to borrowers whose risk of default is unusually high, and who are therefore charged a rate of interest considerably less favorable than prevailing rates. People considering subprime mortgages should get their credit and finances in order before proceeding.

Once you have decided on a mortgage product, you may want to get a written “lock-in” agreement from the lender. The lock-in agreement should include the rate you have been offered and how long the lock-in period lasts. If the lock-in agreement expires before you close, you may want to obtain a new one.

The typical mortgage loan can be either a 15- or 30-year loan. A 30-year loan will have a lower payment, but it will cost you more in the long run due to the interest that will accrue. Your loan amount will be the purchase price of the home plus closing costs minus any down payment you make.  A lender can pre-approve or pre-qualify you for a loan.  Pre-qualifying demonstrates to the seller that you serious about buying his or her home. Pre-qualifying also gives you a price range for homes you should be looking for. One important thing to consider is that you may qualify for more money than you are comfortable paying back. If you can comfortably afford only a $150,000 home, don’t buy a $200,000 one just because you can pre-qualify for it.

The federal government incentivizes home ownership by offering a mortgage interest tax deduction. Thus, the interest you pay is offset to some extent, depending on your tax bracket. If your marginal tax rate is 25% and your annual interest payment is $10,000, for example, then you will get to deduct $10,000 from your income, saving you $2500 in taxes. Thus, if your mortgage’s interest rate were 8%, the net effective carrying cost of the loan would be only 6%.  Visit our taxes page for more information.