What First-Time Homebuyers Need to Know About Mortgages

Key Takeaways:

1. Mortgage rates are influenced by various factors including mortgage type, credit score, loan amount, and loan term.
2. Adjustable-rate and fixed-rate mortgages have different interest rate structures and associated risks.
3. The difference between interest rate and APR is essential to understand, as APR accounts for additional mortgage-related expenses.
4. Discount points and credits offer different ways to manage your mortgage costs, either by paying upfront to lower the interest rate or accepting a higher rate to reduce closing costs.

Navigating the mortgage process for the first time can be overwhelming, but understanding the factors that influence your mortgage can empower you as a first-time homebuyer. In this guide, we'll cover essential aspects of mortgage rates and types to help you feel more in control.

What determines your mortgage rate?

Your mortgage rate plays a major role in determining the interest and the total amount you'll pay over the life of the loan. So naturally, you’ll want the lowest rate possible – and that rate is a bit of a moving target: Multiple factors contribute to your mortgage rate, including the economy, and your financing needs, such as:

• Mortgage type: Different types of mortgages come with varying rates.
• Your credit: A higher credit score often results in a lower rate.
• Loan amount: Borrowing less can lead to a lower rate.
• Loan duration: Shorter-term loans generally have lower interest rates.

Your rate also depends on several other factors:

• Deciding between an adjustable-rate or fixed-rate mortgage (adjustable rates are usually lower initially, but they can change at predetermined intervals throughout the loan's life).
• Paying for points upfront to lower your rate (more on this shortly).
• Opting for premium pricing, which reduces your initial expenses in exchange for a higher interest rate.

While there are many factors affecting the interest rate, many of them are under your control. The type of loan you choose, the type of interest rate you select, improvements to your credit score, and more can empower your home loan search. We’ll discuss some of these next.

What are your home loan options?

As a first-time homebuyer, you may feel overwhelmed by the many different home loan options and terminology. Whether it’s a conventional loan, a VA loan, or an FHA loan, the difference between all mortgage types can be determined by three overarching categories:

• Rate structure: Mortgage loans may be offered as either fixed or adjustable. The key difference between the two is that a fixed-rate mortgage has a “fixed rate” for the loan’s entire term. An adjustable-rate loan will have a fixed period at the beginning, but then it shifts to an adjustment period.
• Backing: Most mortgage loans are offered by private lenders, but not all lenders are able to offer every type of mortgage. FHA or VA loans are guaranteed by government agencies; however, these loans are provided by government-approved lenders.
• Loan size: Mortgages are categorized as either conforming or jumbo based on whether the amount borrowed fits within a specified lending limit.

You’ll find that different loan types offer varying rates. Some of the lowest rates come from government loans, while conventional loans can offer competitive rates for those with excellent credit. Before applying for a mortgage, it's always smart to review your credit report to see if there are any errors to fix.

When can you lock in a mortgage rate?

Mortgage rates can change daily, which is why it's crucial to secure a good rate when you find it. It’s important to keep in mind that a rate quote is not a rate lock. Receiving a rate quote from a lender won’t guarantee that rate until you enter an agreement to reserve it for a particular amount of time. The most common rate locks are for 30 days, and typically allow for extensions up to 60 days. A rate lock allows you to lock in your mortgage rate for a period, ensuring you know precisely what you'll pay if you close on a home within that timeframe. Knowing how long you can lock in a mortgage rate helps you plan better and avoid potential surprises.

What is the difference between interest rate and APR?

When comparing mortgage quotes, it's essential to understand both the interest rate and the annual percentage rate (APR). While the interest rate determines the amount of interest you'll pay on the loan, the APR is usually higher as it factors in additional mortgage-related expenses such as broker fees and discount points. This makes APR a more accurate measure of the total cost of your loan.

What are points and credits on a mortgage?

As a first-time homebuyer, you may wonder about the meaning of points and credits on a mortgage. Discount points allow you to buy down your rate by paying an up-front fee. Each point equals one percent of the total loan amount, typically lowering the interest rate by .25 percent for the loan's life. For example, one discount point on a $500,000 loan equals $5,000. Paying this amount could lower your rate by .25 percent for the loan's life.

This is also where the origination fee for the loan comes into play.  It’s charged by a lender as compensation for processing your loan, as well as underwriting it. Be sure to thoroughly research and shop around for a lender, as not all mortgage companies will charge the same amount in fees.

Knowledge is power

As a first-time homebuyer, you might feel overwhelmed by the mortgage process. However, understanding the factors that affect your mortgage rate and the various loan options available to you can help you feel more in control. By familiarizing yourself with the different aspects of mortgages, such as rate locks, the difference between interest rate and APR, and the impact of discount points, you'll be better equipped to make informed decisions and ultimately secure the best mortgage for your needs. Knowledge is power, and it's essential to arm yourself with it as you embark on your journey to homeownership.

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