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How Mortgages Work

Typically, a mortgage loan is a long term commitment. However, it is important to find a mortgage to fit your needs. The most popular term is 30 years. Understanding the process can make you more comfortable and confident in your negotiations. A mortgage requires you to pledge your home as the lender’s security for repayment of your loan. Generally for a purchase transaction:

Down payment + Amount of mortgage loan = Purchase price

When you sign a mortgage agreement, you are agreeing to repay the principal plus interest. During the first few years, most of your payments will be applied toward the interest you owe. This is because the interest each month is calculated on the outstanding balance. As the balance is reduced, so is the monthly interest. During the final years of your loan, your payment amounts will be applied primarily to the remaining principal.

You can choose a mortgage with an interest rate that is fixed for the entire term of the loan. A fixed-rate mortgage gives you the security of knowing that your interest rate will never change during the entire term of the loan. An adjustable-rate mortgage (called an ARM) has an interest rate that will vary during the life of the loan, with the possibility of both increases and decreases to the interest rate.

As the buyer, you pay in cash a down payment, that is a percentage of the purchase price of the home. The down payment represents your equity in the house. Lenders often view mortgages with larger down payments as more secure because you have more of your own money invested in the property.

A lender may charge a loan origination fee or discount points. Simply put, a point is a unit of measure that means 1 percent of the loan amount. The more points you pay, the lower the interest rate. Usually, for each point you pay for a 30-year loan. Your interest rate is reduced by about 1/4 (.25) of a percentage point. Paying points can be good if you plan on keeping the mortgage loan for more than three years.

The closing (or, in some parts of the country, settlement) is the final step. At the closing, your mortgage is activated, and you are given the keys to your new home. Closing costs are a mystery to most first-time buyers. One reason is that they are not standard and vary from state to state. Items may include transfer taxes and recording taxes, title insurance, survey, attorney fees, discount points, appraisal, and document preparation fees.

Check out the Lender Comparison Chart. The Chart can be used to get the information you need to make an informed decision on which mortgage lender offers the best deal for you.