What the payment is made of
The payment on a mortgage is the same every month, but the early payments are mostly interest. Borrow $300,000 for thirty years at seven percent and principal and interest come to about $1,996 a month. Of the first payment, roughly $1,750 is interest and under $250 reduces the debt. Over thirty years you would pay about $418,000 in interest on top of the amount borrowed. The same loan over fifteen years at 6.5 percent costs about $2,610 a month and about $170,000 in total interest. Most payments also include property tax and homeowners insurance, collected monthly by the lender.
Fixed, adjustable and the loan types
A fixed-rate loan keeps its rate for the full term and is the default choice for anyone planning to stay. An adjustable-rate mortgage holds an initial rate for a set period, commonly five, seven or ten years, then resets periodically against a market index within stated caps. It suits a buyer confident of selling before the first reset. Conventional loans reward strong credit, FHA loans accept lower scores and smaller down payments in exchange for mortgage insurance, and VA loans serve eligible service members and veterans.
What lenders measure
Underwriting rests on your credit score, about two years of income and employment history, your down payment and reserves, and your debt-to-income ratio, which is all monthly debt payments, including the new housing payment, divided by gross monthly income. The traditional guideline is housing at no more than 28 percent of gross income and total debt at no more than 36. Lenders will often approve more, but their approval measures their risk, not your comfort.
Shopping for the loan
- Apply with at least three lenders, such as a bank, a credit union and a mortgage broker, within the same two weeks, so the credit inquiries are scored as one.
- Compare the rate, the APR, the lender's fees and the cash to close on the Loan Estimate, a standardized three-page form that each lender must send within three business days.
- Ask about points, which are prepaid interest: one point costs one percent of the loan and typically lowers the rate by about a quarter of a percentage point, which pays off only over many years.
- Lock the rate once you have a signed purchase contract, and note the date the lock expires.
Tip One extra principal payment a year shortens a thirty-year loan by roughly four to six years, depending on the rate. Confirm first that the lender applies the extra to principal.
