Preliminary Home Search: Mortgage Basics

Simply put, a mortgage is a loan you take out to finance the purchase of your home. It's also a legal contract stating that you promise to pay back the loan on a monthly basis. Your monthly payment typically goes toward interest, taxes and insurance as well as the loans principal.

There are literally hundreds of variations of mortgages. Fortunately, there are just a few basics you need to know in order to understand most of them.

Fixed-rate mortgages have a fixed interest rate over the term of the loan. By far, most mortgages are fixed-rate mortgages. The main advantage of a fixed-rate mortgage is that your monthly payment never changes. The disadvantage is that if interest rates fall below your fixed-rate, and you want to lower your rate and consequently your mortgage payment, you'll have to refinance.

Adjustable-rate mortgages (ARMs) start with a lower interest rate than a fixed-rate mortgage for an introductory period—typically 1, 3, or 5 years. After that, the rate adjusts, usually annually, based on a pre-determined index. An ARM is a good choice if you're expecting to live in your home for less than five years and can also help you qualify for a larger loan.

The term of your mortgage is the number of years you have to pay back the loan. Most people opt for 30-year terms, but 10-, 15-, 20-, and 40-year terms are also available.

The down payment is the difference between how much you borrow and the purchase price of your home. And, in spite of what most people think, you don't need a big down payment to buy a home. There are many low and even zero down payment loans.

Get approved for your home loan before you shop Why apply for a mortgage when you haven't even started looking for a house yet?

You’ll be in a better position to negotiate because the seller knows that you're already approved for your mortgage and that your offer is good. Having an approval gives you these advantages as a buyer:

• You know exactly how much home you can afford, eliminating the guesswork.
• You're in a better position to negotiate a lower purchase price because the seller knows your offer is good.
• Once the appraisal and title work's been done, you can close on a home in days, not weeks, potentially saving the seller a lot of money—another bargaining chip.
• You're a virtual cash buyer—it's like shopping for a home with the money in your pocket.

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