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Home > Financial Tools > Advice & Planning > Real Estate Tools > Demystifying Mortgages

Demystifying Mortgages

Demystifying Mortgages - It's a money thing - 3%25 APR - There's more to a mortgage than the annual percentage rate (apr). Also consider insurance, taxes, admin fees and any penalty fees that may apply. illustration of boat on the oceanFour Questions to Ask Yourself Before Signing a Mortgage

Asking the right questions is an important part of every financial decision you make, and home ownership is no exception. If you’ve been thinking about buying a place, preliminary research will turn up a long checklist of questions for you to ask at every part of the process. There are questions for your financial institution, questions for your mortgage broker and questions for your real estate agent. But what about the questions you should be asking yourself?

Owning a home is likely the largest financial commitment you’ll make in your life, and it’s easy to get caught up in details pertaining to debt-to-income ratios, the real estate market, current interest rates and amortization schedules. But financials are only a part of the picture. In order to make a truly smart decision, you need to acknowledge and accommodate some personal factors along with the financial ones.

Asking yourself the following four questions will help you determine whether or not you’re ready to own a home:

1. Why do you want to own a home?

Seriously, why is owning a home important to you? (Don’t answer with what you think you should answer; be honest with yourself.) Are you looking to build equity? Does it just seem like something a “successful adult” needs to do? Do you see it as an investment? Do you think renting is somehow inferior to owning? Are you just fed up with your landlord? Do you see it as a symbol of your freedom and independence? Do you have a Pinterest board of home renovation ideas you’re dying to try? Do you think it’s something that all (insert age here)-year-olds should do?

There’s no “right” answer to this question (even though some reasons might be more frivolous than others). By simply observing what surfaces when you ask yourself these questions, you’ll get some insight into why you’re contemplating buying a home in the first place. Are your motivations fueled by practicality or insecurity? Is it something you want, or simply something that everyone else seems to be doing? You’ll be able to tell if you’re in it for the right reasons.

2. Are you okay with staying put?

To make the most out of buying a home, you need to be in it for the long haul (which, in this case, usually means at least five to seven years). There’s a reason why short-term home ownership isn’t a thing outside of those real estate flipping TV shows—it’s a great way to lose a lot of money. Your home, like any investment, needs time in order for its value to grow (and that growth isn’t guaranteed, by the way). By selling your home after only a couple of years, you’re at the mercy of real estate market swings and your home may not have increased in value enough to break even—especially when you factor in closing costs and other additional expenses that go along with buying a home. If the thought of staying in one place for more than one year makes you feel panicky, then it might not be the right time for you to buy.

3. Are you happy?

Stability is key when it comes to buying a home, and so anything that threatens that stability could also potentially cause some major headaches once you’ve signed the mortgage papers. Do you love what you do for a living? Do you have job security? Do you enjoy living in your neck of the woods? Is your personal life stable?

You don’t want to be in a situation where you purchase a home and then find yourself faced with the need to change things up. A career change, the start or end of a relationship or a sudden onset of wanderlust could all interrupt your plans to stay put and build equity. Of course, life can be unexpected even when you’re happy—but generally speaking, if you’re pleased with where you’re at, dramatic changes won’t be looming around the corner.

4. Is your savings account up for the challenge?

Have you done your homework and figured out how much home you can afford, based not only on the monthly mortgage payments, but also on all of the other expenses, such as property taxes, insurance, homeowners association fees, and utilities, to name just a few? Regular monthly expenses aside, home ownership can serve up all sorts of expensive surprises, and you’ll want to make sure your savings account is up for the challenge. Save up for inevitable home repairs and maintenance—the financial responsibility of maintaining a household (appliances, heating, plumbing and landscaping) can take new homeowners by surprise. You’ll also want to beef up your emergency fund so that you have some flexibility and can continue paying your mortgage if you suddenly find yourself with health or job troubles. If your savings are healthy, you’ll also want to consider budgeting for moving expenses, furniture, and home upgrades before making the move.
On the surface, home ownership can seem like a smart and appealing option, especially if your mortgage payments work out to be lower than what you would be paying to rent. However, rushing into a mortgage can set you up for a ton of stress (financial and otherwise). Before you buy, check in with yourself to make sure that you’re well prepared, that the timing is right and that you’re doing it for the right reasons.
Understanding a Mortgage
Demystifying Mortgages  Buying a home is likely the biggest purchase of your life, and you’ll usually need a loan to make it happen. Comparing mortgages can be confusing and intimidating—let’s break it all down so you can understand how it works.  •	When shopping for a mortgage, financial institutions have products with an advertised APR, which stands for Annual Percentage Rate. •	But the APR doesn’t tell the whole story—make sure to understand the type of mortgage being promoted. Plus, there are a wide range of additional costs to consider, including insurance, taxes, admin fees and any penalty fees that may apply.   You’ll need to decide between a fixed-rate and an adjustable-rate mortgage  •	Adjustable rate: An adjustable-rate mortgage (also known as a variable-rate mortgage) is based on a chosen index, so it changes throughout the term of your loan. The index is a benchmark that reflects changes in the national economy. If the index goes up, so does your rate and the amount of your payment. If the index goes down, so does your rate and the amount of your payment. •	Fixed rate: In a fixed-rate mortgage, the interest rate is set when you take out the loan and it does not change over time. The amount you pay monthly will stay the same for the entire term of your loan.    It’s a trade-off  •	Fixed-rate mortgages are consistent and easier to budget for, but tend to have higher interest to counter the effect of rates rising in the future. •	Adjustable-rate mortgages usually have a lower advertised start rate, which is very appealing, but can be unpredictable and harder to budget for. •	Think about your income, your future, how long you plan to live in the home and your risk tolerance before deciding which type of mortgage is right for you.   How does the mortgage repayment work?  •	An amortization schedule is how your loan repayment is broken down into regular installments over the term of the loan. •	The schedule shows you how much of each payment is going towards interest and how much of it is going towards the principal.   For example  •	Let’s say you have a $150,000 fixed-rate mortgage with a 3%25 annual interest rate amortized over a 25-year period. Your payment will be $711 per month. •	The monthly payment for a fixed-rate mortgage is the amount paid by the borrower every month that ensures that the loan is paid off in full with interest at the end of its term. •	This is how the interest is calculated for each payment: $150,000 x 3%25 = $4,500 ÷ 12 = $375. •	In your first payment, $375 will go towards interest and only $336 will go towards your outstanding balance. So even though you’ve made a payment of $711, your balance has only decreased by $336. •	The following month, because your outstanding balance is now $149,664, the interest portion of your monthly payment will be slightly lower and the principal portion will be slightly higher ($149,664 x 3%25 = $4,490 ÷ 12 = $374). •	A big chunk of your monthly payments go towards interest at the start of the term. Over time, more of your payment will go towards the principal than towards interest.  •	That 3%25 interest rate may not seem like much, but after 25 years, you will have made $213,395 in payments on your $150,000 loan!   Understand before you sign  People get into trouble by committing to mortgages they don’t understand. All the more reason to know exactly what you’re getting into before signing anything.   A mortgage can be an empowering experience or a burden. It all comes down to your understanding of the mortgage products available, honesty regarding your personal finances and clarity about your life situation.   Sources: Amortization-Calc.com, United States Department of Labor (Bureau of Labor Statistics)
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  • Demystifying Mortgages
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