Step 1 – Get Pre-Approved for a Mortgage
In today’s home-buying environment, a mortgage pre-approval is essential. It not only lets you know what you can afford to buy, but also demonstrates to sellers that you are a willing and able buyer. What’s more, it gives you an important head start in securing an actual loan commitment.
There’s a lot to know when it comes to financing your new home, condo or co-op. You’ll need to get pre-approved for a mortgage, make some important financing decisions and of course, eventually choose a lender.
There’s a reason we put this section first: the first step to buying a property in Chicago should be finding out how much your bank is willing to lend you. When you pre-qualify for a mortgage, your lender will look at your income, your debts and your down payment. It’s important to take that pre-qualification to the next level before you fall in love with a house by getting pre-approved for a mortgage. A mortgage pre-approval will be in writing (generally valid for 90 or 120 days) and will require you to prove your income and credit history. Pre-approvals will include an interest rate guarantee.
Of course, a pre-approval is not a guarantee that a lender will lend you a certain amount of money for any home. Lenders want to know that the home they are purchasing with you (by lending you the money) is worth what you paid. In Chicago, banks generally order independent appraisals of a home before they advance the mortgage money.
Getting pre-approved will ensure that you know how much mortgage you can get, which in turn will help you know what price range of homes you should be targeting in your search. It allows you to focus your house hunting efforts, and eliminates the risk and uncertainty of financing once you find your perfect home.
Step 2 – Mortgage Decisions
Mortgages can seem intimidating, especially for the first-time buyer. Once you’ve qualified for a mortgage, there are some basic decisions you will have to make before you take possession of your house or condo: Mortgage term, amortization, interest rate and type of mortgage. Read on to find out what all of that means and use my handy Mortgage Calculator to estimate what your payments would be.
Mortgage Term and Amortization
The mortgage term and amortization period affect the amount of money you can borrow (and thus the price of the home you can buy), and dictate how much your monthly payment will be.
This is the amount of time a lender will loan you money for – typically from 6 months to 5 years. When the term is up, the remaining amount is payable in full unless you arrange new financing for another term.
Choosing a mortgage term is tricky and requires you to be knowledgeable about trends in the marketplace, as well as having a sense as to the amount of risk you’re willing to endure. If you choose a 6-month term, and interest rates increase drastically in that time frame, will you still be able to afford your home?
Few (if any) of us can pay off the entire principal of a large mortgage in a six month or even a five-year term. Imagine how big your payments would be! To help you out, lenders calculate or amortize, the mortgage payments over a much longer time, often as long as 25 years. They aren’t loaning you the money for a single 25-year period–they’re just calculating the payment schedule as if it will take you that long to pay back the principal plus interest. You will probably renew the mortgage several times during the amortization period, and you always have the option to change the amortization depending on market conditions or your financial situation. The longer the amortization period, the lower your individual payments will be – but this also means you’ll be paying more in interest.
Most mortgage payments consist of two parts: principal and interest. This is known as a blended mortgage payment. Each payment reduces the balance owed on the mortgage by the portion of the payment that is credited to the principal. Over time, the proportion of your payment that reduces the principal balance will increase. The faster you can pay down the remaining balance, the less total interest you’ll pay. There are many ways you can pay down your mortgage faster, from accelerating your payments (e.g. paying biweekly instead of twice a month, for 26 payments per year instead of 24) to making lump sum payments on your mortgage; your lender can help define the right strategy for you.
The interest rate is one of the biggest contributing factors to how much you end up paying for your home, both on a monthly basis and over the life of your mortgage.
Interest is the cost of borrowing money. Interest rates fluctuate with the economy. The interest rate you commit yourself to at the beginning of the term can have a significant effect on the amount you pay each month for your mortgage. There are two basic types of interest rates used in mortgage products: fixed-rate and variable-rate.
Fixed-rate mortgage – Essentially, this means committing to a single interest rate that will not change for the term of your mortgage. This strategy locks in how much of your monthly payment repays the principal vs. going to interest. Fixed-rate mortgages are great in an economy where interest rates are going up, as you never have to risk paying higher interest rates. But in an economy where interest rates are going down, you could be stuck paying more in interest than the going rate. If only we had a crystal ball…
Variable-rate mortgage – With a variable rate mortgage, the dollar value of your monthly payments is fixed for a specific term, while the proportion of interest to principal floats in relationship to the bank’s prime interest rate. If rates go up, more of your payment is applied to interest and less is applied to the principal. If rates drop, more of your monthly payment is used to pay off your principal and your mortgage is paid off sooner. Variable rate mortgages can protect you if interest rates are high at the time you arrange your mortgage; when rates fall, you’re not stuck with high-interest payments, and more of your payment is applied to the principal. But if interest rates increase, that could mean more of your payment is being applied to interest than you bargained for. In some instances, lenders will allow you to convert to a fixed-rate mortgage in this kind of situation.
Types of Mortgages
Conventional mortgage – Aptly named because they are the most common type of mortgage. The lender will loan you up to 80% of the appraised value or purchase price of the property (whichever is lower), and you generally need to come up with the other 20% as a down payment.
Second (and third) mortgages – These are additional financing arrangements behind an existing mortgage, also secured by your property. Secondary financing is generally arranged at a higher interest rate and for a shorter term than the first mortgage.
High ratio mortgage – When you don’t have the 20% down payment required to get a conventional mortgage, a high ratio mortgage can advance you up to 95% of the home’s appraised value or purchase price. However, since you are borrowing more than the usual 80%, the government insists that the mortgage is insured against default and that you pay the cost of the insurance. That cost can be a few percent of the mortgage amount, and is added to the mortgage principal.
Step 3 – Choose a Lender
There are lots of kinds of lenders and mortgages out there. It’s a good idea to go to at least three lenders:
Your own bank. They have your bank accounts, credit cards and investments so they should be motivated to give you a good rate.
A mortgage broker. Mortgage brokers work with a lot of different lenders and will go to them on your behalf to find the best mortgage rate and terms. Usually, broker fees are paid by the banks, so it’s a good way to comparative shop without having to do all the leg work yourself.
It’s important to note that not all of these decisions have to be made before you start looking for a home; the crucial step is getting a pre-approval from a lender—then you’re ready to start the search! Details regarding term, rate and even which lender you use can be decided—and changed—after the actual purchase, all the way up until reasonably close to your closing date (the date you take possession of your new place). However, the more you understand about your options, the better prepared you will be when that magical day comes.
How Leslie can help you with financing:
I keep it real. I’ll look at financial considerations to match what you want with what you can afford. Then I will develop strategies to help you afford what you want.
I’ll take you through the real costs of owning a home – and help you navigate the mortgage and financing waters.
I’ll put you in touch with the very best lenders and mortgage brokers in Chicago.
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