Applying for a mortgage? Learn the basics first

Life is full of financial decisions—how much to save for retirement, how to pay for your kids’ college education, which credit card or car loan to choose, and how to finance and purchase a home. As you reach a financial milestone, make sure you understand the basics, so you can make an informed decision. Time to buy a home? You’ll need to understand the ins and outs of mortgages.  

A mortgage is a loan from a bank or mortgage lender to help you purchase a home. Getting a mortgage allows you to buy a home sooner than if you had to save up the entire purchase price in cash.

A mortgage covers the difference between the total purchase price and the amount of cash you can put down on the home. When you apply for the mortgage, you’ll let the lender know how much you can pay and how much you’ll need to borrow. If they agree to lend you the money, you must agree to pay it back to the lender—plus interest and fees—over a set time period, usually 30 years.

The interest rate, expressed as a percentage of the mortgage, is the amount you’ll be charged for borrowing the funds. It’s stated as an annual rate, and it may vary from one lender to the next. The interest rates you’re offered are based on the structure and terms of the mortgage, as well as on your credit score. Generally, the higher your credit score, the lower the interest rate you’ll be offered and the less you’ll pay over the life of the loan.

You’ve probably been hearing that interest rates are at an all-time low—and that’s a good thing. To give you a little perspective, the average interest rate for a 30-year mortgage in 1990 was 10.13%, and in 2019, it was 4.25%.¹ And they’ve continued to come down, with some 30-year rates even below 3%.²

Mortgage rates: annual averages (%) from 1990 to 2019

What does that mean, in terms of money from your pocket? It means that, if you borrowed $200,000 in 1990, you’d have paid about $1,774 per month and a total of $431,779 in interest over 30 years. But, if you borrowed that amount in 2019, you’d be paying about $983 per month and a total of $154,197 in interest over 30 years.³ While those rates illustrate two extremes, the amount you pay in interest matters—because you still have bills to pay and retirement to save for.

But just because the published rates are low, that doesn’t mean there’s nothing to watch out for. Here are some terms to understand before you apply for your mortgage.

Down payment

The money you put down toward the purchase price of the home is your down payment, often expressed as a percentage of the total sale price. Generally, the larger your down payment, the lower your monthly mortgage payments will be. In many cases, you may be able to put down as little as 5% of the house’s value. If your down payment is less than 20% of the value of the home, however, you’ll probably be required to get private mortgage insurance, referred to as PMI.

Principal

This is the total amount that you’ll actually borrow from the financial institution, excluding interest charges. 

Mortgage term

You’ll agree to pay the mortgage back over a period of time, or the mortgage term. Generally, a longer timeframe means lower monthly payments, but it also means you’ll end up paying more in total over the life of the loan. The most common terms are 15 and 30 years, but some lenders may also offer 8-year terms. 

Fees

When you apply for a mortgage, the lender wants to be sure that both you and your new home are worthy investments. They’ll do a credit check on you and your co-borrower, if you have one, and they’ll do a home appraisal and a home inspection. This research costs money, so they’ll charge you fees. They’ll charge other fees as well, such as title insurance, documentation preparation fees, and others—and all these fees are normally added to the amount you’re borrowing. When you’re comparing mortgages, make sure you compare the fees as well.

APR

The interest rate is the annual rate you’ll pay the borrower for the loan. The annual percentage rate (APR) is also an annual rate, but it includes both the interest rate you’ll pay for the mortgage, plus the fees, in order to give you a better idea of the all-in cost of the loan. This makes it easier for you to compare rates and fees among different lenders.

Mortgage brokers

You can apply for mortgages on your own by going directly to a bank or other financial institution. You may also want to consider using a mortgage broker, who does a lot of the research and paperwork for you. The upside of using a mortgage broker is that they save you time by doing some of the busy work, they can guide you through the process, and, sometimes, they can get you a lower interest rate. But they also charge a fee, so make sure you’re getting enough service to justify the fee before you decide to use a mortgage broker.

Mortgage lenders look at your credit rating and finances to determine whether they think you can cover your monthly payments. But take the time to make sure you really can. Make a budget that includes your new expenses, including home insurance, property taxes, setting aside money for home repairs and emergencies, and saving for retirement. Don’t get in over your head and sacrifice your financial wellness or your ability to save for retirement, just to have a big house—find the house and mortgage that allow you to live the life you want and can afford. 

Home ownership can be wonderful—whether it’s a starter home or the home you’ll live in through retirement. You can put up shelves and artwork without worrying about making holes in the walls—they’re your walls! Getting a mortgage can help you buy a bigger home, and you may be able to deduct your interest payments from your taxes. But mortgages are long-term contracts, and they can include complicated terms. So before you apply, make sure you understand the basics, and then ask questions along the way. And if you’re lucky, you’ll get that picket fence or two-bedroom condo you’ve always wanted.

1 “Historical Mortgage Rates: Averages and Trends from the 1970s to 2020,” ValuePenguin, June 2020. 2 “Mortgage Rates Hit Another All-Time Low,” Freddie Mac, September 2020. 3 “Payment Calculator,” calculator.net, December 2020.