Six key facts you need to know about mortgages

Buying a home is a significant decision, and securing the right mortgage is an essential part of that process.

Mortgages can seem complicated, but understanding the key facts can help you make informed decisions. Knowing how mortgages work is crucial to navigating the process smoothly, whether purchasing your first home or refinancing an existing property. Here are six key facts you need to know about mortgages to help you start your homeownership journey.

1) Types of mortgages: Fixed-rate vs. adjustable-rate

When applying for a mortgage, you can choose between a fixed-rate and an adjustable-rate mortgage (ARM). Understanding these differences can help you select the best choice for your financial situation. From there, you can use a mortgage calculator to know how much you have to pay by opting for one over the other.

You can even use a mortgage refinance calculator from Koalify to save money on your home loan further. Deciding between a fixed-rate or adjustable-rate mortgage depends on your financial goals, how long you plan to stay home, and risk tolerance.

A fixed-rate mortgage provides stability and predictability because your monthly payments will remain, regardless of market fluctuations. An ARM has an interest rate that can change periodically, starting with a lower initial interest rate than fixed-rate mortgages, which makes them attractive to buyers looking for lower initial payments. However, after an introductory period (often five to seven years), the rate can adjust up or down based on the market.

2) The importance of your credit score

Your credit score helps determine whether you qualify for a mortgage and the interest rate you will receive. While credit score requirements vary by lender, a high score of 700 is generally considered reasonable and may qualify you for more favorable mortgage terms. A score of 760 or higher is excellent and can help you secure the best rates. Paying down debt and making payments on time can help boost your score. Because your credit score significantly impacts your mortgage options, reviewing your credit report is a good idea.

3) Down payments and loan-to-value ratio (LTV)

The down payment is the amount of money you pay upfront to purchase your home, while the loan-to-value ratio (LTV) is the percentage of the home’s price you’re borrowing. While it’s common to aim for a 20% down payment, many lenders offer loans that require much less. FHA loans, for example, allow for down payments as low as 3.5%, while VA loans for veterans and active military personnel may require no down payment.

Lenders use the LTV ratio to assess the loan risk. A higher LTV means you’re borrowing a more significant percentage of the home’s value, which can make the loan riskier for the lender. If you can make a larger down payment, you may qualify for better interest rates and have lower monthly payments. However, if saving for a 20% down payment isn’t feasible, there are mortgage options that allow you to buy a home with less upfront cash.

4) Private mortgage insurance (PMI)

If you default on the loan, PMI protects the lender, but it adds cost to your monthly mortgage payment. The cost of PMI is usually between 0.5% and 1% of the loan amount annually and is added to your monthly mortgage payment.

Once you’ve built up enough equity in your home (typically when you’ve paid off at least 20% of the loan), you can request that the lender remove PMI. Alternatively, some loans automatically remove PMI once the LTV reaches 78%. If you’re considering a mortgage with a small down payment, be sure to factor in the cost of PMI when calculating your monthly budget.

5) Pre-approval vs. pre-qualification

Before you start house hunting, getting either pre-qualified or pre-approved for a mortgage is essential. While these terms are often used interchangeably, they have different meanings and implications for home-buying.

Pre-qualification is a helpful starting point but doesn’t involve a full credit check or thorough review of your finances. Pre-approval is a more detailed process where the lender reviews your credit score, financial documents, and employment history. It shows sellers that you’re serious and financially capable, giving you an advantage in competitive markets. While pre-qualification helps get a general idea of your buying power, pre-approval is essential when you’re ready to offer a home.

6) Closing costs and additional fees

In addition to your down payment, several other costs are associated with obtaining a mortgage, collectively known as closing costs. These costs are usually paid at the transaction’s closing, but some lenders allow you to roll the fees into the loan if needed.

Some lenders may be willing to negotiate or cover certain closing costs, particularly if you’re a first-time buyer or have strong credit. It’s also possible to ask the seller to contribute toward closing costs as part of the negotiation process. Understanding closing costs and budgeting for them in advance can help you avoid surprises when you’re ready to close on your new home.

Mortgages can seem complex, but understanding these six key facts will help you confidently navigate the process. From choosing between fixed and adjustable-rate loans to understanding your credit score and preparing for closing costs, being informed about how mortgages work allows you to make smarter financial decisions. Knowing these facts will help you secure the right mortgage and achieve your homeownership goals.