Mortgage

Mortgage

A mortgage, or mortgage loan, is a loan used to buy a home or property. These are secured loans, with the home or property acting as the collateral needed to get the loan. If the borrower defaults, the lender is able to take the property away to recoup their loss. 


 

What Is A Mortgage?

Buying a home outright is not an option for many people today. Your home is one of the most significant purchases you will make your whole life, but it takes too long to save the money that it takes to buy a home with cash. This is why many people opt for taking out a loan – it allows them to stop paying rent and start investing in their own house or apartment.

Loans used for the purpose of buying real estate usually have very specific terms. They are called mortgage loans or simply “mortgages.” These loans may require you to make a down payment, which represents a portion of the total price, while the rest of the money needed to purchase the house is borrowed from a bank or similar financial institution. The loan package consists of a note and a mortgage, and the mortgage puts a lien on the house. That lien can be used to “foreclose” or sell the house if you do not make payments on the note. 

How A Mortgage Works?

A mortgage is actually a type of secured loan. The real estate you buy plays the role of your collateral. That is why they are sometimes also called claims on property or liens against property. This means that, in case you do not pay off your debt as required, your lender has the legal right to claim or repossess your home and sell it to cover the loss.

The sale should not only cover the money the borrower still owes, but also the unpaid interest and any other outstanding fees, as well as the costs of the process itself. This process is called foreclosure.

Mortgage loans can be used both by businesses and individuals. In many cases, they contain two main payments – one comes from the client and the other is covered by the lender. You participate in buying the real estate by making the down payment. The rest of the money is paid by your lender. You have the obligation to pay back this money on agreed terms over a certain period of time. Your payments, typically monthly, will cover the principal you have borrowed, as well as the interest accrued on the loan and any other necessary fees or expenses.

Are You Qualified for a Mortgage?

There are ways to check if you are qualified for a loan to purchase a home, and to find out how much you could potentially borrow. This might be important because your prospective lender will run a hard credit check on you to decide if you are a good loan candidate. If your application is turned down, it affects your credit score, and therefore, your future chances of getting a loan approved can decline.

Of course, you cannot know for sure before you talk to your lender first, but these are some basic criteria you need to meet.

  • Regular monthly income: The overall amount of money you can borrow relies heavily on your monthly income. 
  • A sizable down payment: How much money you can give as the down payment will determine your loan eligibility in some cases.
  • Good credit score: A good or excellent credit score will make it easier for your loan to be approved.

You will also need to research and find a property you can afford. Keep in mind that the overall purchase price of the house does not include other expenses that you need to consider, such as insurance, taxes, and regular upkeep.  Make sure you are also aware of other outstanding debt you might have to determine whether you can keep up with your monthly mortgage obligations. 

It is not essential, but it can be useful to calculate these things before you go talk to your lender and tell them what you have in mind. It could save you some time. Also, you may want to check your credit report for potential errors and make sure it is up to date before you apply for a loan. This way you will have enough time to fix the errors if you find any.

A great option is to enter a preliminary approval process and get your lender’s pre-approval. During pre-approval, you will find out how much down payment you need, what your monthly payments might be, and the maximum amount that you can get for your loan based on your credit score and income. However, this does not guarantee your application will be approved, and you will have to wait for the official process. However, it can be very helpful to keep your home-shopping plans realistic. 

Down Payment

“Down payment” is a complex financial term that is not always related exclusively to mortgage loans. However, in this case, it represents an up-front payment you need to make when your mortgage has been approved – it is how you participate in buying a home with just a certain percentage of the overall price of the real estate.

In most cases, the lender has presented the percentage you need to cover with your payment if you want the loan to be approved. Usually, this percentage can be anywhere between 5% and 25%, but there are programs that sometimes allow you to purchase a home with less of a down payment, or no down payment at all. 

When you make the down payment, your lender finances the rest of the purchase price, and your obligation is to pay off that money, along with the interest and other fees, within the agreed time period. The financed portion is the mortgage loan. 

The down payment can affect your mortgage loan in many ways. First, the bigger your down payment, the smaller the amount of money that you have to finance. This means that your monthly payments will be lower, and your interest rate will often go down as well. 

Also, being able to make a significant down payment assures the lender that you manage your finances well and that you will be able to make your future payments in a timely manner. The bank also has lower risk in lending you the money because you have more money at stake. This lower risk means that you may be able to get very favorable interest rates.

Even though your lender is typically protected against borrowers who default on a loan because of the foreclosure process, foreclosure is still expensive and time consuming and has some risk. Instead, if you make a sizable down payment, like 20% of the purchase price, the lender is less likely to consider you to be a risky client.

Experts say that it is recommended to be patient and save to pay a good-sized down payment as much as possible. This gives the borrowers a chance to lower the total amount of interest they will pay for the whole loan. There are programs designed to help finance the down payment as well, for example, first time homebuyers may be able to use a federal program to get into their dream home faster.

Home Equity

Even when you make a down payment and start paying off your loan, you still do not officially own your home outright because of the lien on the property. However, you did make a payment and participated in the purchase, so you are technically considered the homeowner.

Home equity is the part of your home that you truly own free and clear until your mortgage is completely paid off. The lender you borrowed from does not own any part of your home, but they are using it as collateral, which is noted by the lien on the house.

Note that, if the value of your home suddenly increases, your debt does not change. However, your home equity does—if your home value increases, then suddenly the equity you have in the paid off portion of the house also increases.

Home equity can be used for buying another home, taking out a home equity loan to invest in something, fund your retirement, or a variety of other financial projects and goals.

Types of Mortgages

There are different types of mortgages, and you can make arrangements with your lender so the way you pay them back suits your needs.

Fixed-Rate Mortgage

The most common type of mortgage in the United States is the 30-year fixed-rate mortgage, sometimes called the “traditional mortgage.” The long period of repayment allows you to fit the monthly installments into your budget relatively easily, while the interest stays the same unless you are late with a payment. Although they are less common, 15-year or 40-year mortgages also exist – the length of the repayment period depends on your agreement with the lender. 

In these types of loans, the interest rate stays fixed during the whole period of the loan repayment, and it does not depend on the fluctuations on the market. So, your monthly payments do not change based on interest while you are paying back the loan. Your payments may change based on changes in property taxes or insurance, but your interest rate should remain constant. 

You are also able to pay more than your monthly installment if you would like to do that. However, some mortgages have a prepayment penalty that you should consider in the first three to five years of the loan.

Adjustable-Rate Mortgage

Other mortgages have adjustable rates. These are often referred to as “ARMs.” These loans may be tempting because your interest can drop significantly throughout the life of the loan, which directly affects your monthly payments in a positive way. However, the rate can also increase, and you will not be protected against these changes.

Note that your interest rate is typically lower than average for a period of time at the beginning of repayment, but later rates depend on the market. If the interest rates suddenly become higher, you may not be able to afford your mortgage anymore. However, if you are willing to take this risk, or you are counting on higher income in the future, this adjustment may not be an issue for you. 

Second Mortgages

There are also loans called second mortgages. These are not used for purchasing real estate, but are supported by the home you have. If you have not paid off your home yet, the loan is a second mortgage, but if you already have your house paid in full, then it is a new mortgage put on your home.

How does the second mortgage get paid? You essentially make two mortgage payments on the home—one for your primary lender and the second mortgage holder. The second mortgage lender is basically waiting in line behind your first lender and is the second priority, but both mortgages will usually need to be paid at the same time. People mostly use these loans to cover home repairs, but they can serve other purposes as well.

Refinance Loans

Lenders make it possible to opt for another mortgage if it is more affordable for you. These loans are called refinance loans. When you find a deal that suits your needs better than your current mortgage arrangement (such as lower interest or lower fees), you can take out a new mortgage and pay off the old one with it. Initially, this can cost more than you planned because of the upfront cost to change lenders, but if it is really a better deal, it pays off in the long run.

Reverse Mortgage

Thanks to your down payment, you own a portion of your home outright. The down payment can be useful in other ways, too. For example, it makes a reverse mortgage possible for you. If the down payment you have made is a large sum of money, it can provide income for you. However, reverse mortgages are not as flexible as other types of loans, and the interest may be higher than expected.

In a reverse mortgage, your debt grows over time instead of decreasing, because you are not making monthly payments to your lender – they pay you. Your home plays the role of the collateral once again. As the time goes by, you use your home equity turned into cash to cover your expenses, mostly because your retirement income is not high enough. This is one of the reasons why this type of mortgage is only available to residents who are older than 62.

If you take out this kind of loan, you cannot move from your home because you will need to pay it off. In case of the homeowner’s death, the home is typically sold, and the money from the sale covers the debt.

Balloon Loans

There are mortgages called balloon loans that may be risky because you do not have the typical monthly payments, instead there is one huge payment that is usually due after five to seven years from the date that you took out the loan. Some balloon loans also have monthly payment obligations in addition to the balloon payment. 

This type of loan is generally only a good idea if you are absolutely certain that you will have the funds to cover the loan when the repayment day comes. 

Where to Take Out Mortgage Loans?

Typically, people take out mortgage loans from:

  • Banks
  • Credit Unions
  • Mortgage brokers
  • Online lenders

Different lenders will have different conditions and fees, as well as interest rates. You will usually have to pay for an origination and closing fee, which is in addition to the monthly installments.

Online Mortgage Calculators

It is possible to calculate the numbers before paying an official visit to a lender. There are online calculators that can give you an idea of what you can expect.

However, they may only serve as general orientation and cannot give accurate numbers. Only banks and employees at financial institutions can do that.

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References
  1. https://www.investopedia.com/terms/m/mortgage.asp
  2. https://definitions.uslegal.com/f/foreclosure/
  3. https://home.howstuffworks.com/real-estate/buying-home/mortgage.htm
  4. https://www.moneyunder30.com/get-approved-for-a-mortgage
  5. https://www.thebalance.com/mortgages-home-loans-4073270
  6. https://www.investopedia.com/terms/d/down_payment.asp
  7. https://www.homefair.com/articles/mortgage/down-payment-options.asp
  8. https://www.bankrate.com/finance/mortgages/10-ways-to-come-up-with-a-down-payment-1.aspx
  9. https://www.consumerfinance.gov/ask-cfpb/what-is-a-prepayment-penalty-en-1957/
  10. https://www.reversemortgage.org/about/