You’re driving through neighborhoods, looking for your future home. You find “the one” and start asking yourself, “How will I pay for this?” A lot of homebuyers, especially first-timers, can get confused by the next step—lending. It’s nothing a little preparation and understanding of the right terms can’t solve.
What do you need to know about mortgages? Take a look at these essential terms to get started.
A mortgage is a loan and its supporting documents used to purchase a home. Mortgage lenders abide by strict guidelines to deter the possibility of taking on borrowers likely to default on the mortgage.
This type of mortgage uses an interest rate that doesn’t change over the life of the loan. This is the only type of loan that the South Dakota Housing Development Authority (SDHDA) offers.
This type tends to have a lower interest rate for a shorter period of time; however, it can be adjusted based on market conditions, which is usually impacted by the U.S. Treasury Index. The adjustable rate tends to be locked in for five to seven years before it’s available to change.
A professional appraiser conducts a physical inspection and sets an estimated value (the appraisal value) based on the inspection and comparable homes in the market.
This is the amount you pay upfront. Most lenders require a specific portion of the loan to be paid at closing in order to qualify for a mortgage. South Dakota Housing Development Authority provides downpayment and closing cost assistance. Ask your lender about South Dakota Housing Development Authority's Fixed Rate Plus loan option. If you qualify, you can get up to 3% as a gift to help with the costs of your mortgage. Learn more here.
It’s an important risk-assessment measurement lenders use to determine how capable you are of paying back a loan. “Income” refers to your monthly income and is compared against your existing monthly payments and future mortgage payments. Your income is divided into your expenses and is shown as a percentage. A low percentage means you’re a low risk to default on payments.
Another ratio lenders use to gauge risk is the loan-to-value ratio. Also commonly referred to as an “LTV,” this ratio is calculated by dividing the loan amount by the appraised value or purchase price—whichever is less. For example, an $80,000 loan on a $100,000 home equals an 80 percent LTV.
The higher the percentage, the higher the risk. Lenders typically give buyers a lower interest rate if the buyer’s LTV is less than or equal to 80 percent. If your LTV clocks in at more than 80 percent, you won’t necessarily be turned away, but you may have a higher interest rate and be required to take out mortgage insurance.
Private Mortgage Insurance (PMI)
Borrowers may be required to obtain private mortgage insurance as a guarantee to the lender, that, until the 80 percent LTV threshold is achieved, the lender is covered from default. To obtain this insurance, borrowers pay a monthly premium on top of existing payments.
Lenders sometimes require borrowers to pay an origination fee. This fee may include other fees covering the cost of application, appraisal and any other follow-up work and/or costs associated with establishing the loan.
These costs range from attorney fees, recording fees and other costs required to finalize a mortgage.
This is the difference between the value of the home and the mortgage. As the value of the home increases over time and as the loan is paid off, the equity of the home generally increases.
At closing, borrowers are typically required to set aside a percentage of yearly taxes and homeowner’s insurance to be held by the lender. These funds are held by the lender to make payments for your homeowner’s insurance and property taxes. The funds are collected on a monthly basis, along with your loan payment.
This term is used to describe the amount of money borrowed for a mortgage. Interest is based off of the principal amount. So if you have take a $100 loan from a friend, that is the principal amount. If he charges you two percent interest, you pay $2 in addition to the $100 principal amount.
Amortization is essentially a scheduled breakdown of how a borrower will repay a loan. Typically, this includes a breakdown on how much interest and principal is paid month-by-month over the mortgage’s duration.
Before finalizing the mortgage, the borrowers are required to obtain property insurance on the new home. The policy must list the lender as loss payee in the event of a fire or other disaster.
Sometimes called “loan discount fees,” a point is equal to a percentage of your loan. Often in order to get a lower interest rate, lenders allow borrowers to "buy down" the rate by paying points. It comes down to prepaying interest to lower your interest rate for the remainder of the loan.
Good preparation is half the battle when it comes to finding a good lender for your mortgage. Get your credit report tidied up, and pay off as many existing debts as you can. When you start looking for a lender, let a few compete for your business. Compare and contrast different rates and fees. Check out South Dakota Housing Development Authority’s participating lender list to get you started.