What Is a Mortgage? – How Do I Get One?
When a borrower goes to a bank or even another lending organization for money, they are getting a mortgage. The house itself serves as collateral for the mortgage. The lender can foreclose on the home and sell it to recoup its losses if the borrower stops making payments and defaults on the loan.
When it comes to mortgage loans, 30 years, 20 years, or even 15 years are common for term length. During this time (the “term”), you will be responsible for repaying not only the principal borrowed but also the interest accrued on that principal. Mortgages are paid back over time, typically monthly, with payments that include both principal and interest.
How Does a Mortgage Work?
Mortgages allow buyers (both private individuals and commercial enterprises) to finance the acquisition of real estate. Over the course of a set number of years, the borrower will make principal and interest payments on the loan until the debt is paid in full and the borrower owns the property outright. Full amortization is standard in conventional mortgages. That is, the loan’s regular payment cost will remain the same, but the loan’s principal and interest will be repaid in varying proportions over time. In most cases, borrowers can choose between a 30-year and 15-year mortgage.
Mortgages can also be referred to as claims on property or liens. Lenders can take back properties through foreclosure proceedings if borrowers default on their mortgage payments.
A residential homebuyer’s pledge of the home to the mortgage lender gives the lender a security interest in the dwelling. If the buyer default on their payment, the lender’s interest in the property is protected in this way. When a mortgage is in default, the lender has the right to foreclose, which means they can sell the property and use the proceeds to settle the obligation.
Types of Mortgages
Mortgages come in a variety of forms, each with its own set of requirements for things like down payments, credit scores, and loan amounts. Which choice is best for you depends on your specific situation and borrowing objectives.
- Fixed-Rate Mortgage – A fixed-rate mortgage has an interest rate that does not vary over the life of the loan. The interest rate you’re offered for a mortgage will depend on several factors, including your credit, your down payment, the length of your loan, and the lender you choose.
- Adjustable-Rate Mortgage – ARMs are mortgage loans with interest rates that are subject to vary after an initial fixed-rate period (often five, seven, or ten years). The rate is subject to annual adjustments after the initial one. There are several variables that can affect whether rates go up or down.
- Jumbo Loans – Jumbo loans are quite similar to conforming loans, except that their loan amounts are over the maximum allowed by Fannie Mae and Freddie Mac. Any mortgage in excess of $510,400 (or $765,600 in high-cost areas) is considered a jumbo loan, which can result in additional regulations and/or higher interest rates.
- Balloon Loans – A balloon loan is a mortgage in which the borrower, even if they keep making their regular monthly payments, will still owe money at the end of the loan’s term. These loans are not fully amortized since the repayment plan extends beyond the loan’s original duration.
- Government-Backed Loans – Direct-issue mortgages and insured mortgages both have the backing of the government. Direct-issue loans are made available by the government via various departments and organizations, such as the Federal Housing Administration, USDA, and VA. Homeowners with lower incomes or smaller down payments are the typical borrowers for these types of loans.
Another variety of mortgages backed by the government is the insured loan. There are a variety of government-backed mortgage schemes available, such as the Federal Housing Administration and the United States Department of Agriculture. However, for these loans to be approved by the FHA, they must meet their specific guidelines.
Mortgage vs. Loan: What’s the Difference?
When one party accepts cash from another and promises to repay the money at a later date, the deal is called a loan. Mortgages are specific kinds of loans that are taken out in order to finance real estate. One example of a loan is a mortgage, however, mortgages are by no means the only kind of loan.
Secured loans are what mortgages are. A secured loan is one in which the borrower puts up some kind of collateral with the lender in case the borrower defaults on payments. The residence itself serves as the collateral in a mortgage transaction. Foreclosure is the legal procedure by which a lender reclaims property from a borrower who has defaulted on mortgage payments.
How to Qualify for a Mortgage?
To get a mortgage, borrowers start off by submitting an application to a mortgage lender. Lenders typically need borrowers to prove their financial stability before approving a loan. Statements from financial institutions, tax records, and verification of current work status may be required. A credit check may also be performed by the lender.
A lender may extend a loan to a borrower for up to some maximum amount and at some rate of interest if the request is approved. Pre-approval allows homebuyers to file for a mortgage either after they have found the perfect property or while they continue looking. In a competitive home market, a buyer who has already been pre-approved for a mortgage may stand out from the crowd because sellers will know they can afford the purchase.
Closing is the meeting between a seller and buyer to finalize the terms of a contract. The borrower now pays the lender the initial deposit. The buyer will sign any outstanding mortgage agreements, and the seller will pass the property’s ownership to the buyer and collect the purchase price. At closing, the lender may assess origination costs (in the form of points) for the loan.
What Does a Mortgage Payment Include?
The acronym “PITI” refers to the four main parts of a mortgage payment: principal, interest, taxes, and insurance. There may also be additional charges added to the total.
- Principal – Your mortgage’s principal is the total amount you borrowed to buy a house. For example, if you borrow $90,000 to assist cover the cost of a $100,000 house, the $90,000 you borrow would be considered principle.
- Interest – If you borrow $1,000 from a bank, the bank will charge you interest, which they will describe as a percentage. Basically, interest is the yearly price tag attached to using someone else’s money as a source of funding. Each month, interest will accumulate, and your contribution each month will be enough to cover the interest for the entire month. In addition to interest, you’ll have to pay points as well as other closing costs when you receive a mortgage.
- Property taxes – In most cases, the lender will include the property tax payment in the monthly mortgage payment. The lender will put the funds into an escrow account and use them to cover your property tax obligation when it comes due.
- Homeowners Insurance – In the event of a natural disaster, fire, or other calamities that causes damage to your home, homeowners insurance will help protect you and your lender. Your mortgage lender will include the cost of insurance premiums in your monthly mortgage payment; the lender will then hold the funds in an escrow account until the time comes to pay the insurance company.
- Mortgage Insurance – It’s possible that a monthly premium for private mortgage insurance will be added to your mortgage payment (PMI). With a traditional loan, this insurance is needed if the down payment is less than 20% of the home’s price.
When Does a Mortgage Make Sense?
Simply put, a mortgage is necessary when purchasing a home when the buyer does not have enough cash on hand to cover the total purchase price in one lump sum. Consider that, if you’re in the market to buy a property, you probably won’t want to fork over the full asking amount in cash right away.
You can avoid this massive one-time expenditure by placing a down payment (an upfront contribution of a fixed percentage of the home’s worth) and financing the remaining cost through a bank loan. Borrowing money from a bank (a mortgage) comes with the obligation to repay that money plus interest; in exchange, you get to live in the house and make any improvements you choose to it.
Final Thoughts
Most homebuyers can’t afford to pay for a house with cash, therefore mortgages are a necessary step in the process. There are numerous mortgage options to choose from, so you should be able to find one that works for you. More people are able to get mortgages because to a variety of government-backed initiatives.
