Two Minute Money: How to navigate your first mortgage

Turner Cowles
·Producer

There’s a house for sale in your dream neighborhood, and you want to buy it. After all, owning a home is part of the American dream, right?

Unless you’ve got a ton of money saved up, you’ll have to get a mortgage — which is a type of loan that uses your home as collateral. As one rule of thumb, you can afford a mortgage that’s 2.5 times your annual pay (or maybe less, depending on your financial obligations).

Let’s say you earn $60,000 and found a house that costs $150,000. You probably don’t have $150,000 to pay for a house right now. To qualify for a conventional mortgage, you’ll need to put down anywhere between 5% and 20% of the cost of the house, according to Zillow.

You should probably put down at least 20%; otherwise, you’ll have to pay the additional expense of mortgage insurance.

Once you make a down payment, you will need to apply to get a mortgage to cover the rest of the house’s cost — roughly $120,000. That’s twice your $60,000 salary, meaning this should be an affordable mortgage. You can apply for either a fixed-rate mortgage or an adjustable-rate mortgage.

A fixed-rate mortgage locks you in to an interest rate for the life of your loan, leading to the same payment every month. Meanwhile, adjustable-rate mortgages have interest rates that fluctuate throughout the life of the loan. (Adjustable-rate mortgages were blamed for the subprime mortgage crisis, as many borrowers could no longer pay their mortgages once their rates increased.)

Different banks offer mortgages of varying length, but one of the most popular is a 30-year fixed rate mortgage because it usually offers the lowest monthly payment. The current average interest rate for a 30-year mortgage is just over 4%.

If you miss too many payments, the bank can evict you from the house and resell it. That’s called foreclosure. But foreclosing on a house is an expensive and time-consuming process for a bank, so they’ll run a few checks on you to make sure you’re a good borrower before selling to you. This is where having a good credit score really pays off.

In June, the average FICO credit score for a borrower who closed a conventional loan was 729, according to a report from Ellie Mae, a loan origination software company. A good credit score generally ranges from 700 to 740.

Have a low credit score? Read on to find out why your credit score matters and how to get it up.

Check out Yahoo Finance’s new personal finances series, Two Minute Money, for quick explanations of some of the most important questions involving your money.

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