When I was a little kid, I truly had no idea how people paid for houses. No. Clue. OK, if I’m being honest, I didn’t quite know how people paid for houses by the time I hit adulthood, either. It was not until recently that I finally figured out how this whole “home ownership” thing works.
What piqued my interest was when I started to dream of owning my own property. If an apartment was on sale for $1.6 million — a “steal” in my Brooklyn neighborhood — I wanted to know: Did the buyer need to have a duffel bag with $1.6 million inside of it? Did the money go to the owner of the house, a broker, the bank or someone else? How did people have $1.6 million, anyway?
Since living in New York City made it clear that it would take winning the lottery, robbing a bank or both to find myself able to afford a house, I never really felt like I needed to know how it all worked ... until a bunch of my friends started buying (more affordable) houses in other parts of the country. That was when I started tagging along to see how it all worked, and when I finally learned that no, you don’t need to come armed with a briefcase of bills.
What is a mortgage?
When buying a house, buyers typically have to put down a certain percentage of the total cost. This is the down payment. There are also costs associated with inspecting and closing on the house, separate from the house’s listing price. After you put down that first big payment towards your house, the bank uses your credit history and score to determine how much it will loan you towards paying down the rest of the money over a certain period of time. That loan is called a mortgage. According to Nerdwallet, the minimum down payment depends on what type of mortgage you secure and the requirements of the lender.
How much interest do you have to pay on a mortgage?
APR stands for annual percentage rate. This is the percentage the bank tacks on as interest whenever you secure a loan; basically the price of being able to borrow so much from the bank.
Your credit history will determine your APR. The better your credit history and the more you submit for a down payment, the lower your APR. Say you want to buy something that’s $12, but you only have $2 in your pocket, so you need to borrow $10 from a friend. You have proof that you will have $10 by next week because you show your friend that you have a job and that the job pays you consistently. You also have proof that you will pay your friend back on time because you’ve borrowed from other friends before and they can all attest that you paid them back in a timely manner. That’s essentially your credit score. Based on that information, your friend lends you the $10 with a two-week fixed rate of 4%, which is 40 cents. That means you have two weeks to pay back the $10, with an added $.40 in interest paid to your friend.
Say that the friends you borrowed from in the past have mixed results about your ability to pay them back on time. This would give you a lower credit score and signal to a potential lender that you are a riskier candidate. Your friend agrees to lend you the $10 but because of the low credit score, has told you that you have to pay them back with a two-week fixed rate of 10%. That means you have two weeks to pay back the $10 with an added $1 in interest.
A mortgage is also attached to a time limit for paying off the loan. The most common lengths of time for a fixed-rate mortgage (meaning you'll be paying the same APR until you have paid back the loan) are 15 years and 30 years. If you are not able to pay back the loan within the time parameters you initially agree to, you may be allowed to refinance your mortgage, which means you can go back to your lender and work out another deal that will give you more time to pay off your loan. The quicker you can pay off the money you owe, the less you will owe in interest over time.
When should you apply for a mortgage?
With the Federal Reserve cutting interest rates to nearly zero because of the coronavirus crisis and fixed-rate mortgage rates falling a little less than half a percentage point between mid-March and mid-April, many may be wondering if now is the best time to apply for a mortgage. According to NBC senior business correspondent Stephanie Ruhle, that depends on your individual financial situation.
"Applying for a mortgage right now depends on your job security and the cash you have on hand," Ruhle told TMRW. "If you do have a nest egg and job security, now could be a good time to apply. If you don’t have as big of a cushion, consider readjusting your timeline. Lenders will be more strict, so be prepared to prove that you’re a responsible borrower up front.”
To find out what house you can afford, lots of sites like Zillow and Trulia offer calculators to help you figure out what kind of numbers you need to be putting up in order to get qualified to buy the house of your dreams, but they aren’t super specific. It’s best to talk to your financial planner or bank loan officer to get a more detailed picture of what you can afford.
In short, no, you don’t need $1 million dollars to buy $1 million-dollar house. But with APR and mortgage rates that allow you sometimes decades to pay back that $1 million dollars, you actually need more — just not all at once. Leave the suitcase of money under the bed.