Mortgage Guide: Everything You Need to Know

A mortgage is likely the largest loan you will ever take.

How Lenders Qualify You

Mortgage underwriting is standardised and predictable. Four factors drive the decision.

Credit score. For conventional loans, a FICO of 620 is the common floor, with the best pricing from 740 upward. FHA loans accept lower scores from 580 with 3.5% down. Below 580, FHA requires 10% down. Every 20-point band typically shifts your rate by a small margin, which compounds considerably over 30 years.

Debt-to-income ratio (DTI). The percentage of gross monthly income consumed by debt payments. The front-end ratio covers housing costs alone, and lenders generally want this below 28%. The back-end ratio includes all debt: cards, car loans, student loans, and the proposed mortgage. Most conventional lenders cap the back-end ratio at 36% to 43%. Our DTI calculator computes both ratios from your figures.

Down payment. 20% avoids private mortgage insurance entirely. Conventional loans allow 3% down for first-time buyers, FHA requires 3.5%, and VA loans for eligible veterans require nothing. Below 20%, PMI applies, typically 0.3% to 1.5% of the loan amount annually, and it disappears once you reach 20% equity, though you often have to ask.

Appraised value. The lender lends against the lower of the purchase price or the appraisal. If the appraisal comes in below the agreed price, you must either renegotiate or fund the difference in cash.

Note that gift funds are acceptable for a down payment on most loan types, but lenders require a gift letter documenting the source and confirming no repayment is expected. The money must also be traceable through bank statements.

Fixed vs Adjustable Rates

Fixed-rate mortgages lock the rate for the entire term. Your principal and interest payment never changes. Predictability is the entire benefit, and it is a significant one over 30 years when rates could move substantially in either direction.

Adjustable-rate mortgages (ARMs) have a fixed introductory period, typically 5, 7 or 10 years, after which the rate resets periodically based on an index plus a margin. The initial rate is lower than a comparable fixed rate. The risk is the reset: a 7/1 ARM fixed at 6% for seven years might adjust to 9% in year eight, raising the payment by hundreds of dollars monthly.

ARMs also carry caps: an initial adjustment cap limiting the first increase, a periodic cap limiting each subsequent change, and a lifetime cap limiting the total. Read all three. A 2/2/6 ARM allows a 2% first increase, 2% per adjustment thereafter, and 6% total above the start rate. On a 6% start, the maximum is 12%.

An ARM is reasonable if you are confident you will sell or refinance before the fixed period ends, or if you plan to pay the loan off aggressively. It is a poor choice if you intend to hold for the long term and would struggle with a higher payment.

There is also buydown territory: paying points upfront to reduce the rate. One point costs 1% of the loan amount and typically reduces the rate by about 0.25%. On a $300,000 loan, one point costs $3,000 and saves roughly $45 a month, which takes about 67 months to recover. Worth it only if you will hold the loan well beyond that.

The Full Cost Beyond Principal and Interest

The most common budgeting error is comparing mortgages on principal and interest alone. Four other costs are unavoidable.

Property taxes. Usually collected monthly in an escrow account and paid annually by the lender. Rates vary enormously by location and can be 1 to 3% of property value annually. On a $400,000 home at 1.5%, that is $6,000 a year, or $500 a month, which can exceed the difference between two competing interest rates.

Homeowners insurance. Mandatory while a mortgage is outstanding. Typically $1,000 to $3,000 annually depending on location, property value and risk factors including flood and wildfire exposure. In some coastal or fire-prone areas it is considerably more, and can be difficult to obtain at all.

Mortgage insurance. PMI on conventional loans below 20% down, or the FHA mortgage insurance premium. FHA's upfront premium is 1.75% of the loan amount, plus an annual premium. These are real monthly costs.

Association fees. For condominiums and some planned communities, monthly dues covering shared maintenance. These can range from $100 to over $800 monthly and count toward your DTI calculation.

Add these to principal and interest to get the true monthly payment. Our mortgage calculator includes them and produces the complete figure.

Closing Costs and What They Cover

Closing costs typically total 2% to 5% of the loan amount, and they surprise most first-time buyers.

Lender fees include origination, underwriting and processing, commonly 0.5% to 1.5% of the loan amount combined.

Third-party fees include the appraisal, title search and title insurance, survey, and inspection. Title insurance is the largest of these and protects the lender against ownership claims.

Prepaid items include property tax and insurance escrow funding, plus prepaid interest from closing to the end of the month.

Government recording fees for filing the mortgage and deed.

You receive a Loan Estimate within three business days of applying, and a Closing Disclosure at least three business days before closing. Compare the two carefully. Increases in certain categories are restricted by regulation, and an unexplained increase is grounds for a question.

Sellers sometimes agree to contribute toward closing costs as part of negotiation, particularly in a slower market. This is worth asking for, especially if you are stretching to afford the down payment.

Worked Example: What a $400,000 Home Actually Costs

A household with $110,000 gross annual income buys a $400,000 home with 10% down, taking a $360,000 mortgage at 6.5% over 30 years.

Principal and interest: $2,275 a month. Over 30 years the total repaid is $819,000, of which $459,000 is interest on a $360,000 loan.

Property tax at 1.4% of value: $5,600 a year, or $467 a month.

Homeowners insurance: $1,800 a year, or $150 a month.

PMI at 0.6% of the loan annually because the down payment is below 20%: $2,160 a year, or $180 a month.

Total monthly payment: $2,275 + $467 + $150 + $180 = $3,072.

Now the DTI check. Gross monthly income is $9,167. The front-end ratio is 3,072 ÷ 9,167 = 33.5%, above the 28% guideline. If the household also has a $420 car payment and $180 of student loans, total debt payments are $3,672 and the back-end ratio is 40.1%. That is within the conventional 43% cap but at the upper end.

Underwriting may approve this, but the affordability question is separate from approval. Consider what the household actually has left: $9,167 gross, less roughly $1,900 in tax and deductions, less $3,072 housing, less $600 other debt, leaves approximately $3,595 for everything else. Food, transport, utilities, savings and emergencies come out of that.

Now test the worst month. If the roof needs replacing, or one partner loses work for two months, there is $3,072 of housing cost that does not flex. At a 33.5% front-end ratio there is some resilience, but not a great deal.

Two adjustments change the picture materially. Waiting to accumulate a 20% down payment removes $180 a month of PMI immediately and reduces the loan to $320,000, cutting principal and interest to $2,022 — a total monthly saving of $433, or $5,196 a year. Alternatively, buying a $350,000 home instead of $400,000 reduces both the loan and the tax and insurance base, compounding the saving.

The rate matters, but the down payment and the purchase price matter more, and both are within the buyer's control in a way that rates are not.

Mortgage Types Compared

Risks and Points of Caution

• Stretching to the approval limit. What a lender approves and what you can afford are different numbers. Underwriters cap DTI at specific thresholds, not at your comfort level.
• Ignoring taxes and insurance. Principal and interest can be less than half of the total monthly cost in high-tax areas.
• ARM reset risk. A payment that jumps hundreds of dollars after the fixed period is a genuine risk to plan around, not a theoretical one.
• PMI not removed automatically. Reaching 20% equity does not always trigger removal. You typically must request it in writing.
• Closing cost surprise. Budget 2% to 5% of the loan amount on top of the down payment, plus moving costs and immediate repairs.
• Insurance availability. In some high-risk areas, homeowners insurance is expensive, restricted or difficult to obtain at all. Confirm insurability before making an offer.
• Deferred maintenance. A home costs money to maintain. Budget 1% to 2% of value annually for repairs whether or not they occur this year.

Buying a Home: The Sequence

1. Check your credit report and score, and correct any errors at least three months before applying.
2. Calculate your DTI including all existing debt. Use the DTI calculator.
3. Determine your true monthly payment including taxes, insurance, PMI and any association fees. Use the mortgage calculator.
4. Get pre-approved rather than pre-qualified. A pre-approval involves verified documentation and carries real weight with sellers.
5. Save beyond the down payment for closing costs, moving and an emergency reserve.
6. Get quotes from at least three lenders, including a credit union and a mortgage broker.
7. Compare Loan Estimates line by line, not just on rate.
8. Confirm homeowners insurance is available and affordable before making an offer.
9. Read the Closing Disclosure against the original Loan Estimate and question any unexplained increase.