Banks and private mortgage lenders commonly offer first mortgage loans. However, it’s important to understand exactly how first mortgage funding works and how it differs from other options like second mortgage. This article aims to help you get a clear picture of what a first mortgage entails and the process to acquire this type of financing.
A first mortgage is the primary loan that you take out to buy a home. If a property is financed by several mortgage loans, the first loan is considered the first mortgage. Your property will serve as the collateral. First mortgages are paid for in monthly installments over an agreed-upon term, typically 10 to 30 years.
A first mortgage is usually mistaken for the first mortgage taken in an individual’s name, but it actually just means the original loan taken out on a property. A buyer can have multiple properties in their name. For instance, if a homebuyer takes out a mortgage for three different properties, then the mortgages of all three properties are considered the first mortgage.
Buyers typically need to pay a percentage of the property’s cost upfront as a down payment and borrow the rest. The borrowed amount will then be paid off monthly until the loan is repaid.
The first mortgage takes priority over any second mortgage or junior lien attached to the property. For example, if you default on your loan and your property is foreclosed, the first mortgage lender will have the first claim to the proceeds of the foreclosure sale. The second mortgage lenders will just get the remaining proceeds, if any. However, if you owe property taxes, they’ll have to be repaid first before any other claims, and if you’re a business and file for bankruptcy, the court will decide which entity can take the first claim.
First mortgages are generally less risky for lenders. Thus, you typically get lower interest rates and higher loan amounts, perfect for big purchases like a home or property. The first mortgage lender will provide finance up to a percentage of the property’s market value. Before you take out a first mortgage loan, look at your credit score as that can affect the interest rates, and make sure that you can afford the monthly mortgage payments with your take-home pay or business revenue.
As you make your monthly payments, you build up your home equity, which is the amount of your home that you actually own. You can borrow more money against your home equity, which in essence, is your second mortgage. When you take out a second mortgage, you’re essentially withdrawing equity value from your property.
Second mortgage lenders typically allow homeowners to borrow up to 80% of their home’s value, less the amount owed on the first mortgage. For example, if your home is worth $600,000 and you still owe $200,000, the amount you can borrow against the equity is only $280,000. Here’s the math:
$600,000 x .80 = $480,000
$480,000 – $200,000 = $280,000
As mentioned, the first mortgage takes precedence over the second mortgage if the homebuyer defaults on the loan. For example, if a homebuyer secures $300,000 first mortgage on a property and obtains a $40,000 second mortgage on the same property a few years later for any purpose such as home improvement or loan consolidation, the first mortgage will be given priority after the property is foreclosed and sold. If the homebuyer has only already repaid $50,000 and the proceeds of the foreclosure sale is $260,000, the first mortgage lender will receive the balance of $250,000, and the second mortgage can claim the rest, which is only $10,000 in this case. Since this poses a greater risk to the second mortgage lender, they usually command higher interest rates to offset the possibility of the borrower defaulting.
You need to be financially ready for the down payment which is around 20-25% plus other loan costs and fees. Lenders will also look into your credit score and debt-to-income ratio to assess how you can afford the monthly payments. Evaluate your financial situation and make forecasts as necessary. This way, you can better decide which loan term to get. Shorter terms like 10-year loans can save you interest over time but come with higher monthly payments. Also, shop around to gauge the best interest rates and rate lock options.
The first mortgage requirements depend on whether you’re getting a conventional loan or a government-backed one, but in general, you need to:
The approval process of first mortgage loans can be a bit time-consuming, but since the loan amounts are higher and interest rates are generally lower, first mortgage loans can be very helpful in materializing big purchases and investments.
First mortgage lenders typically calculate how much you can afford to borrow by looking at your monthly gross income and expenses. They also look into many other factors including your credit score, loan-to-value ratio, debt-to-income ratio, the property’s value, the property type, the desired loan term, and so on. In general, your question should not be ‘how much can I borrow’ but ‘how much can I afford’?
The interest rates on a first mortgage generally depend on the borrower’s risk profile and the broader market conditions. If the market is highly competitive, lenders may try to offer lower interest rates to attract business. A higher inflation rate may also lead to higher interest rates. It’s best to shop around and compare interest rates to get the best deal. As of 2024, the average interest rate for 30-year terms is around 6.28%.
Lenders usually charge higher interest rates for borrowers with poor credit scores to compensate for the increased risk, or they may require a larger down payment if you have a bad credit. One solution is to add a co-signer or actively work on credit repair to get the best deals. There are also alternative lenders you can explore in the form of credit unions or online lenders.
It’s best to set the right expectations or consider a less expensive purchase if your credit score needs a tune-up.
Lenders usually offer an amount of 4-6 times your income, but the final amount ultimately depends on how much you can afford. The amount of down payment also matters as well as the type of property and your risk profile. There are ways to boost your commercial mortgage borrowing power. You can consider paying off debts since lenders typically look at how much money you currently owe. You can also close credit card accounts since financial institutions may also factor in your access to credit. As early as possible, you also should take care of your credit rating to get the best interest rates and loan opportunities for those big purchases.
You can also just extend the loan term to better afford the monthly repayments. This can increase the total amount of interest you’ll have to pay in the long term, but this can make your monthly obligations more manageable. Some lenders even consider up to 35 years of loan term.
This calculator is intended for illustration purposes only and exact payment terms should be agreed with a lender before taking out a loan.
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As mentioned, you’re free to shop around before you choose a mortgage loan. You can consider getting a mortgage preapproval to get a sense of how much money you can borrow to purchase your desired property. To do so, you would have to provide documentation including state-issued ID, pay stubs, federal tax returns, bank account statements, investment account statements, and credit report. You’re not obligated to apply for a loan if you request for preapproval, so take the time to shop around to make a more informed decision.
Once you decide to formally apply for a first mortgage loan, you still need to submit the necessary documentation and prepare for the closing costs and other fees including property tax, mortgage insurance payments, down payment, appraisal fees, attorney fees, and so on.
From application to approval, the process usually takes 4-6 weeks. This depends on the type of loan and the financial institution you’re working with. Some could take even faster as early as two weeks while others may take months depending on the possible complications that may arise. There’s no fixed period, and the outcome is also not guaranteed. To streamline the process, just make sure that all the documentation is complete and accurate, and stay responsive in case the lender requests additional information.
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