What is a Mortgage?
Virtually every home transaction these days will require you to borrow money from a lender to close the deal. But how much can you borrow?
What is a Mortgage? The Basics
Virtually every home transaction these days will require you to borrow money from a lender to close the deal. But how much can you borrow? What factors go into determining your mortgage terms? It’s always important to get the correct information, which is why I would recommend consulting with a mortgage professional.
A mortgage professional can look at your financial history, check your credit, and ensure you can repay the loan amount.
What is a Mortgage?
A mortgage is an agreement that grants lending institutions security on their loans. If you fail to meet the terms of the agreement, the lender may have the right to pay off the owing amount by selling your home.
There are many mortgage products that lenders offer. Still, generally, there are two basic kinds of mortgages: conventional mortgages that allow you to borrow up to 75% of the purchase price or appraisal, and high-ratio mortgages that allow you to borrow beyond 75% as long as mortgage insurance is used.
What are the key components of a Mortgage?
Amortization Period – the amount of your monthly mortgage payment is in part calculated on how long it would take to pay off the loan in a given period fully.
Amortization periods are generally 20 or 25 years – the longer the period, the lower the monthly payment will be. Payments mostly go towards the interest. Because interest factors greatly to our payments, it is beneficial to have a shorter amortization period or accelerate your payments to save on interest over time.
Term – Your mortgage contract term is different from the amortization period. There will be a specified term dictating when the remaining amount owed on the loan will be due in your mortgage agreement.
Typically, 5-year terms are used. After this term, if you do not have the means to repay the loan, you can negotiate to refinance the loan.
What is a Mortgage based on?
A simple test of your ability to repay a mortgage loan is called the Gross Debt Service Ratio (GDSR). A general rule of thumb is that no more than 30% of your gross monthly income should be exceeded in your monthly payments.
This calculation can provide an approximate mortgage payment amount you can afford:
Take your Gross Monthly Income
+ Co-Signors gross monthly income (if applicable)
+ Any Additional Income
= Total Monthly Income x30% = Maximum Monthly Mortgage Payment
Other Financial Factors
These days almost everyone has a credit card, a car, or other monthly debts that factor into our finances. These financial obligations factor into your mortgage loan with the Total Debt Service Ratio test (TDSR).
Take your Maximum Monthly Mortgage Payment from above
+ any monthly debt payments for cars, credit cards, etc.
= Total Monthly Payment
This Total Monthly Payment should never exceed 40% of your gross monthly income.
This is all great information, but what are you telling me?
The Gross Debt Service Ratio and Total Debt Service Ratio are essential tests to ensure that the mortgage suits both you and your lender.
Consulting with a mortgage professional before you search for a home to buy will give you information on what you can afford. This pre-approval process will help inform you on which homes are within your scope and the size and type of mortgage you can qualify for.
Not sure where to start with mortgages? Call me today, and we’ll talk about your options and connect you with a trusted mortgage professional.