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Life Events, Mortgage

What is Mortgage Amortization?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

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The difference between your home’s value and how much you owe on your mortgage is your home equity. With each mortgage payment you make, mortgage amortization — or paying down the loan in installments — is at play, and each monthly payment brings you closer to owning your home outright.

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What is mortgage amortization?

Mortgage amortization is the process of paying off your loan balance in equal installments of principal and interest for a set time period. The interest you pay is tied to the balance of your loan (your principal) and the mortgage rate. When you first start making payments, most of the payment is applied to the interest rather than the principal.

Your principal payments catch up with interest over time until your loan is paid off. Once it reaches a zero balance, it becomes a “fully amortized loan.”

How mortgage amortization works

The easiest way to understand mortgage amortization is to look at how monthly mortgage payments are applied to the principal and interest on an amortization table. There are two calculations that occur every month.

  1. The first calculation measures how much interest is paid based on the rate you agreed to. The interest charge is recalculated each month as you pay down the balance, and you pay less interest over time.
  2. The second calculation reflects how much of the principal you pay. As the loan balance shrinks, more of your monthly payment is applied to your principal.

If you’re a math whiz, here’s the formula:

A mortgage amortization calculator does the heavy lifting for you. You can see the effects of amortization on a 30-year fixed loan amount of $200,000 at a rate of 4.375% below.

In the first year, you pay more than twice as much toward interest as you do toward the principal. However, the balance slowly drops with each additional payment. By the 15th year, principal payments outpace interest and equity starts building at a much faster pace.

How mortgage amortization can help with financial planning

A mortgage amortization table helps you assess the short- and long-term benefits of adjusting your mortgage payments. Making extra payments over the life of the loan or refinancing to a lower interest rate or term could save you thousands in interest charges over the life loan. Even better: you’ll end up with a mortgage free home sooner.

Using a mortgage calculator to configure a few scenarios, here are some financial goals you might be able to accomplish using mortgage amortization.

Calculate how much money you can save by refinancing

If mortgage rates have dropped since you bought your home, consider refinancing. If you’re in your forever home and don’t plan to move for a while, a half-percentage point drop in rates could make room in your budget to boost retirement savings, your emergency fund or put money toward other long-term financial goals.

The example below shows the monthly payment and lifetime interest savings if you replaced a 30-year, fixed-rate loan for $200,000 at 4% with a new loan with a 3.5% interest rate with the same terms.

While saving $56.74 per month on payments doesn’t seem like much, it adds up to $20,426.83 in interest savings over the loan’s lifetime.

See the effect of making extra payments

The amount of interest you pay every month is directly connected to your loan balance. Even a small amount added to the principal each month reduces interest over time. The graphic below shows how much you’d save adding an extra $50 every month to your payment on a $200,000, 30-year fixed loan with an interest rate of 4.375%.

Figure out when you can get rid of PMI

Borrowers who don’t make a 20% down payment on a conventional mortgage typically pay for private mortgage insurance (PMI). The coverage protects a lender against financial losses if you don’t repay the loan.

Once your loan-to-value ratio, or the loan balance in relation to the home’s value, reaches 78%, PMI automatically drops off. Multiply the price you paid for your home by 0.78 to determine where your loan balance would need to be for PMI to be canceled. Locate that balance on your loan payment schedule for a rough idea of the month and year PMI will end.

Decide if it’s time to refinance an adjustable-rate mortgage

Adjustable-rate mortgages (ARMs) are a helpful tool to save money on monthly mortgage payments. However, ARMs make more sense if you plan to refinance the loan or sell your home before the initial fixed-rate period ends and the loan resets to a variable interest rate.

An adjustable-rate mortgage amortization schedule helps you pinpoint when the loan will reset and gives you an idea of the worst-case scenario on payments. If the adjustments are outside of your comfort zone, consider refinancing your ARM into a fixed-rate mortgage.

The difference between a 15-year fixed and 30-year fixed payment schedule

Refinancing to a shorter term, such as a 15-year fixed mortgage, may save you hundreds of thousands of dollars over the life of a loan — but the trade-off is a higher monthly payment.

The graphs below show the difference between a 30-year amortization schedule for a $200,000, fixed-rate loan at 4.375% and a 15-year amortization schedule for the same loan amount at 3.875%.

The lifetime interest savings for a shorter loan payment schedule is $95,447.16. As long as the $468.31 increase in your mortgage payment doesn’t prevent you from meeting other savings or investment goals, the long-term savings are worth it.

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By clicking “See Rates”, you will be directed to LendingTree. Based on your creditworthiness, you may be matched with up to five different lenders in our partner network.

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Mortgage

Minimum Mortgage Requirements for Buying or Refinancing a Home in 2020

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

If you plan to buy or refinance a home, having a basic grasp of minimum mortgage requirements will help you zero in on the best home loan for your needs. Knowing the lending guidelines for income, debt, credit scores and down payments puts you in a better position to shop around for a home loan.

Minimum mortgage requirements to buy a home

When you purchase a home, lenders review your entire financial picture to ensure you’re likely to repay the loan. Lenders consider the following items:

Down payment amount. A down payment — the upfront money required to buy a home — can come from your own savings, a gift or down payment assistance.

Credit score. Lenders pull your credit to review your scores and assess how you’ve managed credit accounts over time. Typically, the higher your credit score, the lower your interest rate and monthly payment will be.

Debt-to-income (DTI) ratio. Lenders divide your total debt, including your mortgage, by your gross monthly income to calculate your DTI ratio. The Consumer Financial Protection Bureau (CFPB) suggests a DTI ratio of no more than 43%.

Occupancy. Minimum mortgage requirements are the most lenient if you’re buying a home as a primary residence.

Here are the key mortgage requirements for the most popular loan programs:

Loan typeCredit scoreDown paymentDTI ratioOccupancy
Conventional6203%45% (or less), but can go up to 50% in some instancesPrimary
FHA500-579
580
10%
3.5%
43%*Primary
VANo minimum (620 recommended)0%41%*Primary
USDA6400%41%*Primary, in designated rural areas
*Borrowers with higher DTI ratios may be approved in some cases

Conventional loans. Fannie Mae and Freddie Mac have stricter conventional loan guidelines than government-backed mortgages. Here are some conventional programs worth considering:

  • Conventional 97% financing. With no income limits, qualified buyers can borrow up to the maximum conforming loan limit of $510,400 in 2020 (borrowers in high-cost areas have higher limits). However, you must be a first-time homebuyer to be eligible.
  • Fannie Mae HomeReady®. The HomeReady program requires a 3% down payment and isn’t just for first-time homebuyers. Income eligibility varies by location. Borrowers must complete a mandatory homebuyer education course.
  • Freddie Mac Home Possible®. A 3%-down program that provides extra flexibility for sweat-equity down payments and co-borrowers. Income limits also apply.
  • Conventional loans with private mortgage insurance (PMI). Conventional lenders require mortgage insurance to cover the risk of making loans with less than a 20% down payment. Also called private mortgage insurance (PMI), the premium is added to your monthly payment. The lower your credit score and down payment, the higher the monthly PMI cost.

FHA loans. The Federal Housing Administration (FHA) insures mortgages with lenient qualifying guidelines. First-time homebuyers with rocky credit and little saved for a down payment may get approved for a government home loan if they don’t qualify for a conventional mortgage. Features of FHA loans include:

  • Loan limits. FHA loan requirements include limits on how much you can borrow based on where you live.
  • Upfront and annual mortgage insurance. To offset the risk of lending to borrowers with lower credit scores, the FHA charges two types of mortgage insurance premiums: upfront and annual. The first is a lump-sum, upfront mortgage insurance premium (UFMIP) of 1.75%. An annual mortgage insurance premium (MIP) ranging from 0.45% to 1.05% of the loan amount is paid monthly as part of your mortgage payment. FHA mortgage insurance premiums are the same regardless of your credit score.

VA loans. Active-duty military service members, veterans and eligible spouses can benefit from home loans guaranteed by the U.S. Department of Veterans Affairs (VA). Even with no down payment, mortgage insurance is not required for VA loans. Instead, borrowers pay a funding fee to offset the costs of the VA loan program to taxpayers.

USDA loans. Low- to moderate-income families can purchase homes in designated rural areas with a loan guaranteed by the U.S. Department of Agriculture (USDA). You’ll pay upfront and annual guarantee fees, but no down payment is required. Use the USDA property eligibility tool to see if a home near you qualifies.

Minimum mortgage requirements for a refinance mortgage

Lenders use a different set of criteria to approve refinance mortgages versus a purchase loan. Factors considered for a refinance include:

Reason for a refinance. Getting a mortgage to reduce your current monthly payment usually comes with the easiest qualifying guidelines. Some government-backed refinance programs don’t require income paperwork or an appraisal. Tapping equity with a cash-out refinance (which replaces your current loan with a larger loan and lets you withdraw the difference in cash) comes with extra restrictions.

Loan-to-value ratio (LTV). Lenders consider how much money you’re borrowing compared to the home’s value. Refinance mortgage guidelines for LTV ratios are more flexible for rate-reduction refinances than other types of refinance transactions.

Here are the key mortgage requirements for the most popular refinance loan programs:

Loan typeMaximum LTV ratioPurpose of refinancingCredit scoreDTI
Conventional
rate-and-term refinance
97%Reduce rate and payment62045%*
Conventional cash-out refinance80%Withdraw cash from home equity62045%*
FHA streamline refinanceN/AReduce rate and paymentN/A
History of on-time payments
N/A
FHA cash-out refinance80%Withdraw cash from home equity50041%*
VA interest rate reduction refinance loan (IRRRL)N/AReduce rate and paymentN/A
Prove on-time payments
N/A
VA cash-out refinance90%Withdraw cash from home equityNo minimum
(620 recommended)
41%*
USDA refinanceN/AReduce rate and paymentN/A
History of on-time payments
N/A
*Borrowers with higher DTI ratios may be approved in some cases

Home loan requirements vary when it comes to the paperwork you’ll need and how closing costs can be financed. Refinance mortgage closing costs typically run 2% to 6%, depending on your loan amount.

Conventional rate-and-term refinance. This conventional refinance program allows you to reduce your rate and roll in closing costs for up to 80% of your home’s value. Plan on providing income documents again but, in some cases, an appraisal isn’t required.

Conventional cash-out refinance. Replacing your current loan with a larger one and pocketing the difference in cash entails the same process as when you bought your home. You may pay a higher rate if you have poor credit scores. A conventional cash-out refinance doesn’t require any mortgage insurance and is an ideal cash-out choice for borrowers with a credit score of 620 or higher.

FHA streamline refinance. As long as you’ve made at least seven payments on your current mortgage on time, you’re eligible for an FHA streamline refinance. No income verification or appraisal is required. One catch, though: You’ll pay a higher interest rate if you don’t want to pay closing costs out of pocket; they can’t be rolled into your loan amount without an appraisal.

FHA cash-out refinance. Although you can tap equity up to the same LTV as a conventional loan, FHA requires you to pay both MIP and UFMIP again. The FHA program is one of the more common cash-out refinance loans for bad credit.

VA IRRRL. A VA interest rate reduction refinance loan allows eligible borrowers with a current VA loan to refinance without proving income or getting an appraisal. An added bonus: you can roll closing costs into your loan amount.

VA cash-out refinance. Current VA borrowers can tap more equity than conventional or FHA loan programs allow. Full income and credit documentation, along with a VA appraisal, are reviewed for approval.

USDA streamlined-assist refinance. Homeowners with a current USDA loan paid on time in the past 12 months are eligible. No appraisal or income verification are required. Closing costs (including the guarantee fee) can be rolled into the loan amount.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

By clicking “See Rates”, you will be directed to LendingTree. Based on your creditworthiness, you may be matched with up to five different lenders in our partner network.

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What’s the Minimum Credit Score for a Home Loan?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

If you’re hoping to become a homeowner, your credit score may hold the keys to realizing that dream. Knowing the minimum credit score needed for a mortgage gives you a baseline to help decide if it’s time to apply for preapproval or take some steps to boost your credit first.

The minimum credit scores for home loans

A FICO score of 500 is the minimum credit score you need to qualify for a loan insured by the Federal Housing Administration (FHA). Meanwhile, conventional loans require at least a 620 score. These minimum score requirements serve as a starting point for what types of loans you might qualify for. Later, we’ll explain why you should aim for a higher score instead of purchasing a home with bad credit.

Loan typeMinimum credit score
Conventional620
FHA500 with 10% down payment
580 with 3.5% down payment
VANo credit minimum, but 620 recommended
USDA640

Conventional loans. A 620 credit score allows you to make a down payment as low as 3%, but the mortgage payment may be hefty for a few reasons:

  1. The interest rate will be higher to compensate the lender for extra default risk.
  2. Private mortgage insurance premiums (PMIs) are impacted by credit scores and are required with less than a 20% down payment.

FHA loans. The FHA insures 500-credit-score home loans if you can make the 10% required down payment. FHA-approved lenders may approve loans with a 3.5% down payment and a minimum credit score of 580. The FHA limits how much you can borrow depending on where you live.

VA loans. Active-duty servicemembers, veterans and their eligible spouses have access to loans backed by the U.S. Department of Veterans Affairs (VA) with a 0% down payment. The VA doesn’t set minimum credit score guidelines, but many VA-approved lenders require at least a 620 to qualify.

USDA loans. Low- to moderate-income buyers with at least a 640 credit score may qualify for a loan guaranteed by the U.S. Department of Agriculture (USDA). Only homes located in designated rural areas are eligible, and income limits apply. You may qualify with a lower USDA loan credit score in special circumstances.

What is a good credit score to buy a house?

Meeting the minimum score requirement for a home loan will limit your mortgage options, while higher credit scores will open the doors to lower monthly payments and lower interest rates. In addition, a good credit score can also allow you access to more choices for home loan financing.

  • 740 credit score. You’ll typically get the best interest rates for a conventional mortgage with a 740 credit score. If you make less than 20% down payment, you’ll pay for private mortgage insurance (PMI). PMI protects the lender in case you default on your home loan.
  • 640 credit score. Rural homebuyers need to pay attention to this benchmark for USDA financing. Exceptions may be possible with proof that the new payment is lower than what you’re paying for rent now.
  • 620 credit score. The bare minimum credit score for conventional financing comes with the largest mark-ups for interest rates and PMI.
  • 580 credit score. This is the bottom line to be considered for an FHA loan with a 3.5% down payment.
  • 500 credit score home loans. Offered by FHA-approved lenders with at least a 10% down payment.

Mortgage rates by credit score

Your mortgage rate is a reflection of the risk lenders take when they offer you a loan. Lenders provide lower rates to borrowers who are the most likely to repay a mortgage. You can get a glimpse at how lenders assess the risk of different credit scores by looking at the rate mark-up for lower credit scores and down payment amounts.

The table below shows Fannie Mae’s loan-level price adjustment (LLPA) and the related dollar cost of each credit score based on a 3% down payment for a $200,000 loan.

Credit scorePrice adjustmentDollar cost
≥ 7400.75%$1,500
720-7391%$2,000
700-7191.5%$3,000
680-6991.5%$3,000
660-6792.25%$4,500
640-6592.75%$5,500
620-6393.5%$7,000

With every 20 points lower in credit score, the dollar cost of the interest rate increases, reaching $7,000 for the lowest credit score. Rather than charging you the cost as a discount fee, the lenders hike up your interest rate to cover the risk of a lower credit score.

Steps for improving your credit score

Now that you have an idea of the extra cost of getting a minimum credit score mortgage, following some of these tips may help you boost your score.

  • Make payments on time. It may seem obvious, but recent late payments on credit accounts hit your scores the hardest. Set your bills on autopay if possible to avoid forgetting to pay one.
  • Keep balances low. The best plan is to pay your entire balance off as your charge credit cards. But if you do carry a balance, try to keep it at 30% or less of the credit limit.
  • Have a mix of different credit types. Mortgage lenders want to see you can handle longer-term debt as well as credit cards. A car loan or personal loan will help demonstrate your ability to budget for installment debt payments over time.
  • Avoid applying for new accounts. A credit inquiry tells your lender you applied for credit. Even if you were applying to get the best deal on a credit card or car loan, multiple inquiries could drop your scores, and give a lender the impression you’re racking up debt.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.