The Ultimate Beginner's Guide to Home Loans

What is a Mortgage?

A mortgage is a legally-binding document you sign when purchasing a property. Secured by the property itself, a mortgage allows the lender (usually a bank) to claim the property if you don’t repay the loan.

Signing a mortgage may be nerve-racking for a first-time buyer—and for good reason. (After all, "mortgage" comes from the Latin word for “death,” i.e. you’re stuck with this until the day you die, like it or not!) And sure, a mortgage represents a big commitment, often spanning 15 or 30 years depending on the life of the loan. But mortgages are also the simplest, most realistic way for the vast majority of people to buy a home. And if you choose correctly, your mortgage can be an affordable path to owning a home or investment property.

The 4 Elements Included in a Mortgage

So what are you signing yourself on to when you take on a mortgage? A mortgage commits the homeowner to monthly payments that typically encompass four items:

1. Principal

The principal is the actual amount of money you’ve borrowed. This doesn’t include the interest and other items below that are also wrapped into your monthly payment. As you pay your mortgage each month, part of that payment will go towards your principal.

2. Interest

Interest refers to the money you pay for the privilege of having a loan. Interest rates can vary based on several factors, including credit score, home price and loan amount, down payment, loan term, loan type, and more.

3. Taxes

Property taxes are often included in a mortgage payment. Your lender then keeps this money in an escrow account and pays it on your behalf when your tax bill is due.

4. Insurance

Property taxes are often included in a mortgage payment. Your lender then keeps this money in an escrow account and pays it on your behalf when your tax bill is due.

Mortgage insurance is required by the lender when you make a down payment of less than 20%. This includes private mortgage insurance (PMI, which you can read about more in Chapter 6) and insurance required for government-backed loans.



Home Loan Types

The finance/mortgage industry really isn’t very different from other industries. Take the jewelry industry as an example. When you go shopping for a ring, you typically visit a couple of different stores and look through the display case at different options. You might even pick up a couple and take a closer look.

While you can’t physically hold a mortgage, it’s still a product. When it comes to loan options, there are a ton, with each appealing to different types of buyers—some for those without sparkling credit, others for those who live in small or rural areas. No matter your situation, there’s a mortgage type that fits.

In the process of shopping for a mortgage, you’ll want to know a little bit more about the different mortgage types that exist.

Let’s examine four basic categories:

1. Fixed-Rate Loans

The most common and predictable type of loan is a fixed-rate loan. As the name suggests, the interest rate on this type of loan is “fixed” for the duration of the loan. This means it can’t change, regardless of how interest rates fluctuate over time. Most fixed-rate loans come with 15-year and 30-year options (with interest rates stepping up accordingly).

15 vs. 30-Year Mortgages

The vast majority of fixed-rate mortgages offered by banks are in either 15 or 30-year terms, with 30-year mortgages making up a whopping 90 percent of homebuyers’ loans. The 30-year mortgage is what most Americans envision when they think of home ownership. Still, a 30-year mortgage may end up costing more than double 15-year loans, depending on interest rates.

Why do homeowners end up paying so much more for a 30-year loan? Because a mortgage is paid over such a long period of time, interest stacks up—in a serious way. It may be shocking to realize how much of your payment goes to interest versus principal. Because the 30-year mortgage is twice the amount of time as the 15-year option, as a borrower, you’re keeping the lender’s money for 15 additional years, resulting in a serious uptick in the cumulative interest amount.

Still, there are benefits to 30-year loan terms. If you’re paying your loan off over 30 years, for instance, your monthly payment will of course be significantly cheaper. Therefore, you may be able to afford a more expensive home on a 30-year loan than a 15-year loan. Perhaps most importantly, a 30-year loan may free up your funds to invest in other lucrative options. If your interest rate is favorable, other investments used with those funds may offset savings you’d see with 15-year options.

How does this play out in real life? Take a look at this example run through our mortgage calculator showing that the 15-year option, which usually comes with a slightly lower interest rate, results in you paying significantly less over the life of the loan. Your payment is typically higher than a 30 year loan, because you're paying the loan off in half the time. It isn't double the payment, though.


30-Year Mortgage Example

15-Year Mortgage Example

These results are simply meant as an example. To assess your specific loan situation, be sure to visit our mortgage calculator —and understand whether a 15-year or 30-year mortgage is right for you.


Still don’t know which loan to choose? Check out this video assessing the pros and cons of 15 and 30-year loan options.


2. Adjustable-Rate Loans

Whereas fixed-rate loans stay the same until the loan is completed or refinanced, an adjustable-rate mortgage (ARM) actually changes over time. The most common types of ARM loans are 3/1 ARM, 5/1 ARM, and 7/1 ARM. Depending on the type you select, this means your interest rate is set for 3, 5, or 7 years and then adjusts annually for the remaining portion of the loan. The benefit is a lower interest rate on the front end. The negative is that you don’t get the chance to lock in a good rate for very long.

3. Government-Backed Loans

While most people get conventional loans—such as the ones discussed in the previous two sections—there are also government-backed loans. A government-backed mortgage is a loan subsidized by the government, which provides protection for lenders against defaults on payments. While not eligible for everyone, these types of loans tend to have higher closing rates and can offer low interest rates. Some of the most common types of government-backed mortgages are federal housing administration (FHA) loans, veterans administration (VA) loans, and U.S. Department of Agriculture’s Rural Development (USDA) loans.

FHA Loan Program

The FHA Loan program (Federal Housing Administration) is one of the most popular programs among first-time home buyers. Here are some of the best things about this program:

  • The minimum down payment is 3.5% of the purchase price.
  • The down payment can be gifted from an approved source. It doesn’t have to be your own funds.
  • The minimum credit score, with most lenders, is 580.
  • Interest rates are lower than conventional mortgage loans in some situations.

Most first-time buyers take advantage of this program because of the small down payment and lower credit scores allowed.


Is an FHA loan right for you? Check out this video to understand why a duplex financed with an FHA loan could be ideal for a first-time buyer.

VA Loan Program

The VA Loan program (Veterans Benefits Administration) is specifically for military veterans and people currently active in the military. Geared towards those who choose to serve our country, this loan offers some significant benefits.

Here are some of the best things about this program:

  • There is no down payment required for this program. Yes, 100% financing is allowed!
  • Both veterans and people active in the military qualify.
  • You can use your VA certificate of eligibility more than once.
  • The interest rates are lower than conventional mortgage loans in some situations.
  • There is no minimum credit score requirement; instead, VA requires a lender to review the entire loan.
  • No PMI (private mortgage insurance—more on this below) payment is required by the lender.

Anyone who has served in the military should seriously look into the VA mortgage program. It allows no down payment and no PMI payment, which is the only mortgage program that allows both.

The USDA Rural Development Loan

The USDA loan (United States Department of Agriculture) is for home buyers looking in rural areas. This is one of the most popular first-time home buyer programs for anyone looking outside of a city area.

Here are some of the best things about this program:

  • There is no down payment required for this program. Besides the VA program, it’s the only other no down payment program.
  • The minimum credit score, with most lenders, is 640.
  • The interest rates are similar to the FHA and VA programs—lower than conventional mortgage loans in some situations.
  • This program doesn’t have a PMI payment, but they have their own monthly fee. It’s much less than the traditional PMI payment.

If you are looking in a rural area to buy a home, it’s best to look into this program. Since it’s one of the only two no down payment programs, it’s become very popular with first-time home buyers.

Jumbo Loans

Finally, you have jumbo loans. Also known as a nonconforming loan, a jumbo loan is a loan that doesn't meet the guidelines laid out by Freddie Mac and Fannie Mae regarding credit, income, and asset requirements. These types of loans require a lengthy qualification process, but allow certain buyers to take on much larger loans if they’re able to put down a significant down payment.

Pursue the Home Loan Options That Make Sense for You

The mortgage that makes sense for your neighbor won’t be the same mortgage that works for you, and vice versa. As you evaluate different loan products, it’s imperative that you think about the situational factors involved and make a choice that reflects your needs, priorities, and limitations.

The bank will tell you if there are certain loans you don't qualify for; however, it's up to you to decide whether or not you'll pursue a loan that you’re "qualified" for.

Review Lending Options on BiggerPockets

How Much Mortgage Can You Afford?

So, now you know the loan options available to you as a homebuyer. But what homes are affordable for your specific financial situation, and how much mortgage will you ultimately be able to comfortably pay?

Your household income and the amount of debt you carry are two major factors in determining the mortgage you can afford. A very general guideline says that if you’re debt-free, you may be able to afford up to five times your total household income; this declines to four times your household income if 20% of your take-home pay goes to debt payments—and if you’re paying more than 20% of income to debt, you’re likely able to afford three times your household income.

Keep in mind: These numbers are simply a guideline and not a hard-and-fast rule. The amount of home you can afford also depends on several other considerations. For instance, what amount of money do you want to put aside for investments each month?

3 Factors That Determine How Much Mortgage You Can Afford

There are a number of factors that affect how much a lender is willing to loan for your home. These include:

Debt-to-income (DTI) ratio

Lenders take into account the ratio of your debts (typically car loans, student debt, etc.) to your income.

Loan-to-value (LTV) ratio

Financial institutions use this ratio as an assessment of the lending risk you present. It quantifies the size of the loan taken out against the value of the property securing the loan.

Credit score

A measure of the creditworthiness of an individual, credit score can affect mortgages rates and ability to qualify.

Still, the goal shouldn’t always be to borrow as much as possible for a home. Depending on your financial situation, signing on the dotted line for the largest home loan you can possible obtain could be a recipe for disaster.

Other Considerations

When shopping for a home loan, first consider how much you can actually afford.

Assess the costs of homeownership.

This may include general upkeep, yard maintenance, HOA (if applicable), etc.

Understand how your lifestyle might be affected.

A huge, beautiful house to show off to your friends may seem great in theory, but will you be able to afford that yearly vacation you’re accustomed to taking? What about the investment fund you’ve been building up?

Ask yourself whether house hacking is a feasible option to offset costs.

House hacking is newbie-friendly strategy where you purchase a single family home or small multifamily with enough roo to rent out extra space to offset part or all of the monthly mortgage payment. It can be a solid, achievable way to purchase a first investment property and create a cash-flowing asset out of a liability.

Is house hacking right for you? Explore your options here!

To understand more about what mortgage you can afford (and to start improving your stats in the eyes of lenders), read:

Ask our friends at Better.com about a low-money down, house hacking loan.

Down Payment on a House

A down payment is the money a home buyer gives to the seller to cement the deal. Most often, the rest of the funds owed are paid through a mortgage loan that the buyer obtains. Down payments are usually expressed as a percentage of the home purchase price. For instance, if you were purchasing a $300,000 property and put $60,000 down, that would represent a 20% down payment.

Conventional loans typically require a 20% down payment; however, there are several ways to get by with a lower down payment, including FHA (3.5%). Even conventional mortgages offer options for lower down payments, as low as 5% of the loan price, depending on the loan size and borrower credentials.


How Much Should You Put Down?

The amount of your down payment will depend upon a number of factors:

  • How much money you have saved up
  • The amount of your loan
  • Your age
  • Your marital status
  • Your credit health

Is it wiser to put as much money down on a house as possible? That depends on your current financial situation and goals. Some investors believe in leveraging strong interest rates to their benefit to use debt in a responsible way, efficiently building up their portfolios with borrowed money. Others would rather pay down debt quickly to avoid paying exorbitant amounts of interest (putting more money down significantly reduces the overall cost of a house due to less interest incurred)—or if investing, to enjoy cash flow free of mortgages payments.


How to Pay Down Mortgage Debt

If you do decide to attack your mortgage debt more aggressively, there are several ways to pay down your home loan quickly. When looking to minimize your debt for whatever reason, these tips should help you reach your goals.


1. Send extra

Although some banks have a per-payment penalty fee if you were to pay extra on the loan, many don’t mind when you pay them extra. By doing so and accelerating the mortgage debt pay-down, it not only saves you money in interest, but it also increases your available equity and net worth.

Let’s say you have a 30-year fixed-rate loan for $200,000 with a 4% interest rate. With regular payments, your monthly mortgage payment will be $955 for the life of the loan, for a total of $343,739 (of which $143,739 constitutes interest). If you pay $100 more a month, you can cut your loan term by more than 4.5 years and save more than $26,500 on interest. If you pay $200 more a month, you can cut your loan term by more than 8 years and save more than $44,000 on interest.


2. Try bi-monthly payments

An even easier strategy is a bi-monthly pay schedule. This is simply where you send in half a mortgage payment (principal + interest) every two weeks. When you split your payments this way, it results in one extra monthly payment a year (26 bi-weekly payments = 13 monthly payments).

Using the same example as above, if you make a payment of $477.50 every 2 weeks instead of 1 monthly payment of $955, you could shorten your total loan term by more than 4 years and save more than $22,000 on interest.

Keep in mind, these strategies can be pretty powerful, whether you keep a loan to term or you're the normal mortgage statistic as someone who pays a mortgage for five to seven years before refinancing or selling. The advantage of paying more earlier on is that the typical mortgage is front end loaded with interest and very little principal is paid down. In fact, a break point is approximately 19 years into a 30-year loan, when the portion of money going to principal passes the amount going towards interest.


3. Use sweep accounts

Normally, people pay their bills out of their checking account while their money sits idle most of the month. They say it’s estimated on average in a 40-year period a person's money sits idle for 30 years. This money is leveraged by banks to generate more revenue through what they do best: lending.

What a sweep account does is it enables the borrower to take advantage of the leverage for themselves. This is commonly done by utilizing a HELOC (Home Equity Line of Credit) that's treated like a checking account. So, instead of putting all of your paycheck into a checking account, you put your income stream into the HELOC. By doing so, you pay your HELOC down over time while you use a HELOC check to prepay your first mortgage thus saving money on a lower interest amount, keeping your money moving as opposed to sitting idle.

Interested in a HELOC? Learn more here.

For more information on down payments, read:

And to understand how down payment affects the monthly payments you’ll owe (and play around with down payment amounts to see how it changes your overall loan), be sure to check out our mortgage calculator!



What Credit Score Do You Need to Qualify for a Home Loan?

Your FICO credit score is a major factor lenders look at when seeing whether you qualify for a home loan. Many elements contribute to your approval for a loan, but credit score is the most important. With a lower credit score, for instance, you will likely have a significantly higher interest rate.

Still, the minimum credit score needed can vary significantly depending on the loan you’re applying for and money you’re willing to put down.

Even borrowers with low credit scores may be able to find options that work for them. For instance, it’s common to see first-time home buyers have little money for a down payment or a lower credit score that prevent them from buying a home. These shouldn’t stop first-time buyers from looking into what programs and financing options are available to them. For instance, FHA loans typically require a 580 credit score to qualify for a loan calling for just 3.5% down.

Typical minimum FICO score requirements by loan are as follows:

FHA Loan

580+ credit score

VA Loan

620+ credit score

USDA Loan

640+ credit score

FHA 203K

620+ credit score

Conventional

620+ credit score


Not sure what your credit score is? These websites allow you to check (and monitor) your FICO score free of charge:


And if you find your score needs a boost, be sure to check out our resources for improving your credit score (or building credit from scratch!):


Lastly, be sure to view this video for expert tips on getting approved for your loan (so you’ll go into the application process completely confident and ready to answer questions and provide documentation!):

Let BiggerPockets help you find a lender who has your best interest in mind

What is Private Mortgage Insurance (PMI)—and How Can You Get it Dropped?

PMI stands for private mortgage insurance. Lenders require homeowners to get this when they purchase a house and put down less than 20%. (They would require the same thing for an investment, except that nearly all investments require you put down 20% in the first place, so it’s a moot point.) And they require you put that down because you’ve just made a huge investment, which they’ve financed, and they need to know that if you default on it, they can recoup their costs.

Lenders will allow you to remove the PMI once you’ve paid the equivalent of 20% of your loan. Knowing this, it does make a lot of sense to put as much money down up front as you can for a lot of reasons, one of which is that you can to eliminate the additional PMI cost or lessen the amount you will owe over time. Because the PMI requires 20%, on average it takes about 10 years to get rid of this extra cost on a mortgage that starts with only 5% down.

That said, there are some workarounds for this. The first is refinancing your home, and the second is getting it appraised. Let’s discuss what this looks like.


Refinancing Your Home

Buying in a hot market likely to see rapid appreciation gains? If your home has appreciated significantly in the past year or so, you may be able to drop your PMI. This is possible because if your home appraises enough and you gain a significant amount of equity, you may own more than 20% of your home’s value. How’s that? Well, if the house appreciates $100,000 in a year, and that $100,000 is worth more than 20% of the house value, you now own more than 20% of the house. And that qualifies you to drop your PMI.

Still, this strategy requires you to refinance (read more about refinancing here). One important point to note: Refinancing your home requires getting a new loan, and consequently, you’ll be paying closing costs all over again. That can be expensive, so it’s important to see if it’s worth it over the long-term.


Waiting Two Years

This applies to hot markets again, but if you can wait two years, you can avoid closing costs. If your home has appreciated 25% or more in that two-year time frame, then you only need to pay for the cost of an appraisal (usually $400-500). As long as your primary residence has appraised 25% or more after two years and you haven’t had any late payments in the past 12 months, you are eligible to drop your PMI. If your home is five years or older, you only need it to appraise at 20% or more.

This is a great way to save yourself some money and drop what can be a long and lengthy payment.

Refinance. View lenders who can help you refinance now!

What Are Closing Costs?

When you’re buying your first house, you may be ultra-focused on the down payment—but don’t forget about the closing costs. “Closing costs” is an all-encompassing term that buckets a few different expenses, such as:

  • Attorney’s fees
  • Title search fees
  • Title insurance fees
  • Taxes
  • Lender costs
  • Upfront housing expenses, such as homeowner’s insurance

Some of these costs are fixed, while others may be negotiable. It is also possible to get the home seller or lender to pay some of these costs with savvy negotiation. Regardless, be prepared to budget 2 to 5 percent of the home purchase price for closing costs, depending on the market you’re in.

For more information on closing costs, be sure to read:

Save $200 or more off closing costs. Get pre-approved with Better.com on BiggerPockets.

How to Get Started Buying a House

Now you know the basics of home loans, the types of mortgages available, and what to expect out of the borrowing process. But how do you start taking action towards your home purchase?

6 Steps to Take to Get the Home-Buying Process Underway

Your next steps can be broken out into an actionable list:

  • Do some simple math to determine how much house you can afford (see Chapter 3).
  • Check your finances and determine how much you’ll have for a down payment (see Chapter 4).
  • Check your credit score and understand whether it needs improvement before pre-approval (see Chapter 5).
  • Get synced up with a lender and get pre-approved before starting to look at homes.
  • Do some research (and confer with your lender) to understand current interest rates.
  • At this point, you’ll have a good idea what you can afford. It’s time to start looking for homes!


The Home-Buying Timeline

Statistics show that the time it takes for the average home buyer to complete the entire process, from application to closing, is becoming shorter and shorter. From January 2018 to January 2019, for instance, this timeline for both purchase and refinances loans spanned about 43 days. This is several days shorter than the same period for 2016-2017.

Now more than ever, it’s vital for prospective home-buyers to be prepared for the process, to have all their financials in a row before house-hunting, and to be ready to jump at the good deals left out there. So take what you’ve learned here, create a checklist, and start tackling it!

And be sure to check out these helpful articles to guide you through the home-buying process:

Since 2007, Dave Van Horn has served as president and CEO of PPR Note Co., a $150MM+ company managing funds that buy, sell, and hold residential mortgages nat...
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Mindy Jensen has been buying and selling homes for more than 20 years. She buys houses, moves in, makes them beautiful, sells them, and starts the process all over again. She is a licensed real est...
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Larry is an independent, full-time writer and consultant. His writing covers a broad range of topics including business, investment and technology. His contributions include
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