Saturday , September 24 2022

Mortgage loans, interest rates, lenders: Everything to know

If you’re like the vast majority of Southern Californians, you’ll have to take out a mortgage to buy a home. It will almost certainly be the largest sum you’ve ever borrowed, an order of magnitude more than your last car loan or your most extravagant credit card purchase.

Mortgages aren’t just bigger loans. They also involve more complicated choices than other forms of credit, forcing you to make bets on what the economy and your finances will look like years into the future.

If you’ve never gotten a mortgage before, you may not even know where to start.

How do you find a good lender? How do you judge which loan has the best terms? And how do you decipher the arcane language spoken by bankers and mortgage brokers, filled with acronyms and jargon?

Let’s start with the basics.

Loan Costs

Lenders and the investors who purchase their mortgages take on the risk that you won’t pay back what you owe. They also incur costs in determining whether you are worth that risk. For those reasons, you’ll probably spend a lot more paying off the loan than you borrowed.

To understand how that works, let’s talk about a few terms.

  • Principal: This is the amount you borrowed to buy the house. You will pay all this money back, plus more in the form of interest.
  • Interest rate: This determines how much the loan will cost you in addition to the principal amount. For the first several years, most of what you’ll pay every month will be interest charges, not principal. The rate you pay depends on market conditions as well as your own personal situation. Lenders tend to charge a higher rate if you have worse credit or put less down.

    During the pandemic, many people locked in rates below 3%, but borrowing costs have been rising. To see the latest average mortgage rates, visit Freddie Mac’s website. The averages are based on people with excellent credit who put 20% down, so your rate may be higher.

  • Points: This typically refers to an upfront fee you pay to reduce your interest rate and potentially lower the total cost of your mortgage. Each point equals 1% of your original principal. Some lenders also use the word points to refer to fees that are not tied to the interest rate, according to the Consumer Financial Protection Bureau.
  • Closing Costs: This is a catch-all term for the total amount you will pay to close the deal for your house. These costs do not include your down payment, but do include things such as points and fees for the services provided, including originating the loan, appraising the property and searching for other claims on the title, along with required prepayments of taxes and homeowner’s insurance.

    Your lender will give you an estimate of closing costs well before closing. The average in California is 1.02% of your home price, according to a report from Forbes Advisor.

Mortgage options

There are many different flavors of mortgages, but they fall into two main categories: fixed rate and adjustable rate. Like the names suggest, fixed-rate mortgages are loans with an interest rate that stays the same for the entire life of the loan. With adjustable-rate mortgages, the interest rate changes over time.

To buy a home, most people opt for a 30-year fixed mortgage, the longest mortgage typically available. The longer payback period increases the amount of interest you’ll pay over the life of the loan, but it shrinks your monthly payment.

One of the big benefits of this mortgage is security. If you are a renter in Southern California, there’s a decent shot you’ve stomached some pretty hefty rent increases over the years. But with this loan your principal and interest — the largest part of your mortgage payment — will stay the same for 30 years.

You can also find 10- and 15-year fixed-rate mortgages, which typically carry lower interest rates. But because the payback period is so short, the monthly payments are considerably higher. These products are primarily used by people who have paid much of the principal on their original 30-year loan and want to refinance.

Adjustable-rate mortgages also come in different shapes and sizes, but what they all have in common is that your initial rate will change. That initial rate tends to be lower than a fixed-rate mortgage, but it will adjust to a predetermined percentage above a benchmark bank interest rate after a certain number of years. If interest rates go up (as they do during periods of inflation), your rate will go up. If they go down (as they do during recessions), your rate will go down.

The safest adjustable-rate mortgage is a “fully amortizing” one, which is just like a standard fixed-rate mortgage in the sense that it’s designed to pay principal and interest every month. But there’s also a riskier “interest-only” option, in which you’ll pay just the interest on your loan for the initial period. This option offers low monthly payments at first, but when the initial period ends, those payments can skyrocket.

A common adjustable-rate loan is known as the 5/1 ARM. With this type of loan, your initial rate will last for five years, then adjust annually until the loan is paid off. Another popular option is the 10/1 ARM.

“You may want to consider this option if, for example, you plan to move again within the initial fixed period of an ARM,” the Consumer Financial Protection Bureau says on its website. “However, if you end up staying in your house longer than expected, you may end up paying a lot more.”

Andrew Pizor, staff attorney at the National Consumer Law Center, said the predictability fixed-rate mortgages provide is why he recommends them over ARMs, especially today, when despite recent increases, rates are still comparatively low.

“Lock in a low fixed rate,” he said. “When you get an ARM, you are gambling on the direction rates are going to go, and rates are more likely to go up than down.”

More key mortgage terms

When you shop for your mortgage, you may take out one that’s issued or insured by the U.S. government through a federal agency. Or you may get a mortgage that’s later sold to Fannie Mae and Freddie Mac, government-controlled mortgage companies best known for nearly capsizing during the subprime mortgage meltdown. Or you may wind up with a mortgage that a lender holds on its books or sells to private investors.

All these types of loans have somewhat different requirements and costs, so it’s good to know the difference.