Different Mortgages, and How They Can Benefit You
When I think about the word, “mortgages”, I try to think of it from an outsider’s perspective; because for most people, it’s a completely foreign concept until it’s necessary to know what it is. And even then it’s a tough concept to wrap your head around at times, it quickly becomes very important when it’s time to buy or refinance. As I’ve written about before, I have a bit of an unfair advantage in the market compared to other agents due to being in the industry for a couple years, and having my Dad as a knowledge source even now due to him still working in the business . Most of our news and education as adults is disseminated through Facebook or Twitter in 2019, and while that is good for quick hitting news and things to learn, it keeps things pretty shallow. Hence everyone in 2019 thinking they’re smarter on everything than they actually are; myself included. I want to discuss a few things- first, what a mortgage actually is and what it means to obtain one, the different types or mortgages, and how to put yourself in the best position with one for the next decade- that will help give you a better grasp of a huge portion of the home ownership process.
So, what is a mortgage, other than the biggest debt of your entire life and something that is shackled to your ankle dragging you to the depths of the ocean for the next thirty years? (Just kidding, that would be how people mostly see student debt these days.) Primarily, a mortgage is a lien against a home that you want to buy- or currently own and are refinancing- that is secured by the bank because they gave you money to purchase the home. Traditionally, people have thought that you save and save and save and build up 20% of the price of the home they want to buy as a down payment, go put a suit on and walk in to a bank to put on your best face and ask for a couple hundred thousand dollars for the home that they want to buy. Those days are dead and gone due to the advancement of technology and the internet age. Now, (and I DO NOT recommend this for your first home purchase) you can go online and type in a bit of information and basically get pre-qualified in a loan instantly while you’re laying in bed in the morning. The good thing about someone like Quicken Loans is that they have forced the mortgage industry to try and catch up to them with automation and other online processes that make applying for and getting approved for a loan easier and less hands on from the client’s perspective. Your home is collateral to the bank in the same sense that your car that you pay for every month is collateral for that loan. When you sell your home that you’ve gotten a mortgage for, the remaining balance left on your mortgage is payed off first, and then you get whatever is left over (basically- it’s more detailed than that). In summation, a mortgage is you asking for money from a bank, them giving it to you, you pay the bank every month for that loan, and them being paid the remaining balance upon the sale.
While the definition of a mortgage is pretty much the same across the board, there are a lot of different options for how a loan might be configured. You have your traditional conventional loan where you have the 20% to put down, avoiding PMI (private mortgage insurance- a premium that you pay monthly due to having too high of a loan to value ratio). You can also get a conventional loan that has a higher loan to value than that, but you’re going to be hit with that PMI until you build up the equity and hit that 80% LTV number. There is an FHA mortgage, which is a government owned loan that is usually 96.5% LTV, and carries a mandatory monthly insurance premium, once again charged because the LTV is high and the mortgagor wants extra due to the higher risk of the bank lending the money. There are other government loan programs as well that are 100% loans: VA for service members, USDA, THDA, rural loans. USDA, THDA and rural loans make their money off of the fees attached to the front end that become closing costs, so if you’re planning on utilizing one of those products, make sure that you know the costs on the front end and be willing to ask for closing cost help from the sellers. This list doesn’t even include all of the different options that your bank might offer that are specific to them as products that they have crafted to help you as a customer. I know- a lot of options that, as I said earlier, can easily feel overwhelming the first go around. That’s why I think that it’s really important to utilize a loan originator that can navigate you through the process to the point that it is easily digestible.
Inside of the mortgage framework, there are “terms” of the loan, meaning the amount of monthly payments that the bank is going to be given until the loan is paid back in full. The overwhelming majority of loans were 30 year terms. Obviously, this means that if you make the payment given to you each month from the bank with no refinancing along the way, it will take you 360 equal payments to make your loan balance $0. Seems rather overwhelming, right? Most of us can’t commit to a diet plan that lasts longer than 360 hours much less a repayment schedule that will last a generation. The other most popular option is the 15 year mortgage, with, you guessed it, 180 equal payments to pay off your loan balance. A bit more palatable, right? While this might seem like an obvious homerun, there is the drawback of the monthly cost increase- a $515 per month hit to be able to get the shorter mortgage term. If you’re rolling in the dough every month and are just throwing that extra money you make into an investment fund other than your company’s 401k, it probably makes sense for you to transition that money in to your home as you’re going to get more substantial short-term returns on a home compared to the stock market. In my opinion, the smart move is to put yourself in that 30 year timeframe and just pay that extra money a month. Whether that be $50, $100, or $515 a month, every penny added to your payment is going to help you either pay off the balance quicker, or get more money back in equity when you sell. In fact, an extra payment a year can take 7 years off of the term of the loan.
This next paragraph is primarily aimed at people that already own a home. I use $200,000 often because it is a nice, round number, so I’m going to use it again here for the sake of the example. Say that you put 10% down when you bought the home in 2016, and got a mortgage for the remaining $180,000. You’ve only paid down the principal a few thousand dollars because you’re paying more interest in the first few years due to the high principal percentage of the mortgage. However, you’ve gained equity to where your home might appraise for, say, $250,000. What was a 90% LTV is now 70%. (First off-if that’s not enough motivation to buy a home then I don’t know what is.) Now, as I stated before, as long as you stay under that 80% LTV threshold, you’re able to avoid getting hit with an insurance premium. If you take 10% (old LTV of 70% now made 80%) of $250,000, you end up with $25,000. Subtract loan costs associated with another transaction with a bank and a title company, and lets say that you have roughly $20,000 left over. If you refinanced at 80% LTV, at an appraised value of $250,000, you would then owe $200,000 on your mortgage. Now, why in the world would someone do this and add $25,000 to what they owe on the home? Well, say you owe $30,000 in student loans and are paying $500 a month for them. That’s a lot of dough to mark off in the monthly budget. But instead you refinance, pay that $20,000 you have left after closing costs down on your student loan with a refinance of that payment and your monthly payments would DRASTICALLY decrease your monthly payment while only increasing your house payment $100. Net-net, if you’re staying in the home for an extended period of time, it’s going to save you money and you’re still getting that equity boost for the next few years. Plus, you’re borrowing at a lower interest rate than your student loan is probably running at.
In the beginning, I said that mortgages can seem like a foreign concept. And I’m sure a lot of this only slightly opens the Pandora’s Box of what it all means. If you read this and would like to know more, I feel like I have a pretty firm grasp on all of the basic principles of the mortgage process and the industry overall so I would be glad to help go over it with you. And things that I am not able to answer are a phone call away for me to figure out quickly. There are so many ways that being a home owner can benefit you. All the way from finding the perfect neighborhood to call home, to being able to make student loans and other debts more manageable by using equity built up too pay chunks at a time. This isn’t even a total sales pitch for myself. I think ownership is that valuable that it’s much more like friendly advice that it makes much more sense for you to own a home than to be renting.