How Does A Mortgage Work?

A mortgage is a loan for your house. You would use a mortgage to purchase a home. You can also refinance the home in order to gain more favorable terms for your situation, or convert existing home value into cash.

When you get a mortgage, there are two pieces of documentation to sign. The first is a promissory note which goes over the repayment process and specifies your monthly payment and the length of the term. It’s your promise to pay back the loan.

You also sign the mortgage itself which contains these financial details, but also includes the recourse a lender has if you don’t make your payment, laying out specific procedures and penalties. Typically, a lender will have the ability to take the house back if you default on your payments. Once your home is paid off, the lien on your house that allows them to do this is removed.

What Types Of Loans Are There?

Mortgage loans also come in many different flavors. One of the biggest points to know is whether the rate is fixed or adjustable so that it will change over time. Loans also come in a variety of term lengths. The longer the term, the cheaper your monthly payment. The trade-off? You’ll pay more interest than you would on a shorter-term loan.

Another consideration is the investor in your mortgage loan. Conventional loans require a slightly higher credit score than FHA loans, but with a high enough down payment, you can avoid mortgage insurance altogether. Meanwhile, FHA loans will allow you to qualify with a slightly lower credit score than many other options.

Two special programs are USDA and VA loans, both feature the option to get a home loan with no down payment. USDA loans are targeted to encourage development in rural areas or on the outskirts of suburbia. Meanwhile, the VA loans are a benefit for qualifying active-duty servicemembers, reservists, veterans and surviving spouses of those who have been killed in action or passed as a result of a service-connected disability. For those that qualify, the VA loan also offers some of the best interest rates available under any loan option.

There are two different pieces to this. There’s what you’re required to save and then the best down payment for you given your situation.

If you happen to qualify for a USDA or VA loan, no down payment is required. If you’re getting an FHA loan, the minimum down payment is 3.5%.

If you qualify for a conventional loan through either Fannie Mae or Freddie Mac, down payments start at 3% and in no event would you have to put down more than 5% of the purchase price on a primary residence.

However, there are plenty of reasons to make a higher down payment if you can afford it. On a conventional loan, if you put 20% down, you can avoid having to pay for private mortgage insurance (PMI). Otherwise, you can ask that it be canceled once you reach 20% equity.

On an FHA loan, you’ll pay mortgage insurance premiums (MIP) for the life of the loan if you make a down payment of less than 10%. Otherwise, it comes off after 11 years.

Your interest rate is determined in part by a combination of your median FICO® score and the size of your down payment, so holding all other factors equal, a higher down payment should mean a lower rate.

Given this, the real answer to this question is that you should put down as much as you can comfortably afford without compromising other financial goals. Just keep in mind you’ll probably have to furnish the house, as well.