Before you get a mortgage loan you need to know the basics of what it actually is, that’s why we put together this crash course in the anatomy of a mortgage loan. We’re going to cover the basic definitions of some common terms you’ll run into, the actual break down of what you pay each month for your mortgage and then go into some of the most popular types of mortgages for homebuyers.

Terms and Definitions

When you are trying to secure a mortgage loan from a lender these are the mortgage components you’ll need to know about:

Interest rates – An interest rate is the percentage of your loan amount the lender charges you to borrow the money to buy your house. Interest rates are based on: market conditions, your credit score, the size of your down payment and the type of mortgage you get.
Appraisal – This is a written report by an expert that pinpoints a value for your property based on comparable homes in the area, and it’s characteristics. You will need to get an appraisal on your new home that will determine whether or not your property is worth the amount of the loan you’re trying to get from the bank.
Discount points –One point equals 1% of your mortgage amount. If you qualify then you have the option to pay one or more points in order to lower your interest rate. These points are commonly tax-deductible.
Debt–to-income ratio – A formula lenders use to determine the loan amount you qualify for. How much income you have vs. how much you’re already paying in current debts i.e. monthly student loans, car payments, etc.
Origination charge – This fee is paid to the lenders and brokers who originate a loan your home loan for you. It covers fees, document prep, underwriting costs, etc.

Mortgage composition

Your monthly mortgage payment is made up of these 4 components:

Principal – The principal is the part of your monthly mortgage payment which goes toward paying the outstanding balance of your loan.
Interest – Interest, on the other hand, is the part of your monthly payment which goes toward the costs of borrowing the money. For your first several years your mortgage payments will be primarily paying interest.
Taxes – Included in your mortgage payment are taxes charged by the government like property taxes.
Insurance – Every homeowner must have homeowners’ insurance. This part of your mortgage payment pays to protect your home against property damage like fires, wind, and other natural risks.

Types of Loans

Now that you know what all goes into a loan, it’s time to figure out what type of loan is best for you. Generally speaking, your first choice will be whether you want to go with an FHA or Conventional loan. Take a look at a price comparison we put together of FHA vs. Conventional and then read a bit about the most common loans. Here is a shortlist of the most popular mortgages most homebuyers choose from:

Fixed-Rate – This is the most common type of mortgage for homebuyers and is great because it is predictable and easy to budget for. Your rate is fixed no matter how interest rates change in the future. Fixed-rate mortgages are a good idea right now especially because rates are low but expected to rise as the economy (hopefully) continues to improve this year.
Adjustable-Rate (ARM) – As the name suggests an adjustable-rate mortgage is one in which your rate adjusts over time. ARMs are enticing because the initial interest rate is lower than a fixed-rate loan and can last anywhere from six months to several years. However, once the initial period is over the rate will reflect the current rates. Most have a cap on how high the rate can go. This type of loan has many options including starting rates, adjustment schedules and length.
FHA Loan – First-time homebuyers can secure a loan with FHA with as little as 3.5% down and most of your closing costs and fees can be included in the loan. Check out our recent post on 5 Things You Didn’t Know About FHA Loans if you’re thinking it might be right for you.
VA – VA loans are available for veterans. Check out the details at valoans.com
Special FHA loans include loans for fixer-uppers (purchase and renovate) and energy-efficient mortgages where FHA will finance the cost of adding energy-efficient features as a part of your loan. Check out your options at HUD.gov