A mortgage is a type of loan used to finance the purchase of real estate. When you take out a mortgage, you borrow money from a lender, typically a bank or a mortgage company, to buy a home or other property. In exchange for lending you the money, the lender typically charges interest, which is a fee calculated as a percentage of the loan amount, and may also require you to provide collateral, such as the property itself.
This is the total amount of money you borrow from the lender to purchase the property. This is the percentage charged by the lender for borrowing the money. It determines the cost of borrowing and affects your monthly mortgage payments. The term of the mortgage is the length of time over which you agree to repay the loan. Common mortgage terms are 15, 20, or 30 years, though other terms are possible.
This is the amount you pay each month to the lender, which typically includes both principal and interest. The monthly payment amount is determined based on the loan amount, interest rate, and term of the loan. This is the initial upfront payment you make toward the purchase price of the property. It is usually expressed as a percentage of the total purchase price, with common down payment amounts ranging from 3% to 20% or more.
If you fail to make your mortgage payments as agreed, the lender may take steps to foreclose on the property, which means they can seize the property and sell it to recover the remaining balance of the loan. It’s important to carefully consider your financial situation and ability to repay before taking out a mortgage.
Mortgage loan basics:
A mortgage loan is a type of loan specifically used to purchase real estate, such as a home or land. It allows individuals or families to borrow money from a lender to buy property, with the property itself serving as collateral for the loan.
Types of Mortgages:
1. Fixed-Rate Mortgage:
With a fixed-rate mortgage, the interest rate remains constant for the entire term of the loan. This means your monthly payments remain the same, providing predictability and stability.
2. Adjustable-Rate Mortgage (ARM):
An ARM typically offers a lower initial interest rate for a set period, after which the rate adjusts periodically based on market conditions. This can result in fluctuations in monthly payments.
3. Government-Backed Mortgages:
These are loans insured or guaranteed by government agencies such as the Federal Housing Administration (FHA) or the Department of Veterans Affairs (VA). They often have more lenient eligibility requirements.
4. Jumbo Loans:
These are loans that exceed the conforming loan limits set by government-sponsored entities like Fannie Mae and Freddie Mac. They’re typically used for high-priced properties and may have stricter requirements.
5. Loan Amount and Down Payment:
The loan amount is the total amount of money borrowed from the lender to purchase the property. The down payment is the initial payment made by the buyer towards the purchase price. It’s typically expressed as a percentage of the total purchase price. A higher down payment can result in a lower loan amount and potentially lower monthly payments.
6. Interest Rate and Term:
The interest rate is the percentage charged by the lender for borrowing the money. It can be fixed or adjustable. The term of the mortgage is the length of time over which you agree to repay the loan. Common terms include 15, 20, or 30 years.
7. Monthly Payments and Amortization:
Monthly payments typically include both principal (the amount borrowed) and interest (the cost of borrowing). They’re calculated based on the loan amount, interest rate, and term. An amortization schedule outlines how your payments are applied to principal and interest over the life of the loan. Initially, a larger portion of each payment goes towards interest, but over time, more goes towards principal.
8. Closing Costs:
These are fees and expenses associated with finalizing the mortgage loan and transferring ownership of the property. They include appraisal fees, loan origination fees, title insurance, and more.
Standard or conforming mortgages:
Standard or conforming mortgages refer to loans that meet the criteria set by government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac. These criteria include specific loan limits, down payment requirements, and underwriting guidelines. Conforming mortgages are attractive to lenders because they can be sold to Fannie Mae or Freddie Mac in the secondary mortgage market, which allows lenders to free up capital to make more loans.
Fannie Mae and Freddie Mac set loan limits each year, which vary by location. These limits dictate the maximum amount borrowers can borrow while still qualifying for conforming loan status. Loan limits are typically higher in areas with higher housing costs. Conforming mortgages often require a down payment, which is a percentage of the home’s purchase price paid upfront by the borrower. While down payment requirements can vary, they typically range from 3% to 20% of the home’s purchase price.
Borrowers must meet certain credit score and income requirements to qualify for a conforming mortgage. Lenders typically evaluate factors such as credit history, debt-to-income ratio, employment history, and assets. Conforming mortgages often have competitive interest rates compared to other types of loans. These rates can be fixed or adjustable and may vary based on factors such as credit score, down payment amount, and loan term.
Borrowers who make a down payment of less than 20% on a conforming mortgage may be required to pay private mortgage insurance (PMI). PMI protects the lender in case the borrower defaults on the loan and typically adds an additional cost to the monthly mortgage payment. Conforming mortgages can have various features, including fixed-rate or adjustable-rate options, different loan terms (e.g., 15 years, 30 years), and options for government-backed mortgage insurance.
Overall, conforming mortgages offer borrowers a standardized and regulated way to finance their home purchases. By adhering to the guidelines set by Fannie Mae and Freddie Mac, lenders can provide borrowers with competitive interest rates and terms, making homeownership more accessible to a broader range of individuals and families.
Mortgage Principal and interest:
Principal and interest are two components of your mortgage payment:
Principal: The principal is the amount of money you initially borrowed from the lender to purchase your home. Each month, a portion of your mortgage payment goes towards paying down the principal balance. Over time, as you make payments, the amount of principal you owe decreases.
Interest: Interest is the cost of borrowing money from the lender. It’s calculated as a percentage of the remaining principal balance. In the early years of your mortgage, a significant portion of your monthly payment goes towards paying interest. However, as you continue making payments, the amount of interest you pay decreases, while the amount going towards the principal increases.
An amortization schedule is typically worked out taking the principal left at the end of each month, multiplying by the monthly rate and then subtracting the monthly payment. This is typically generated by an amortization calculator using the following formula:
- is the periodic amortization payment
- is the principal amount borrowed
- is the rate of interest expressed as a fraction; for a monthly payment, take the (Annual Rate)/12
- is the number of payments; for monthly payments over 30 years, 12 months x 30 years = 360 payments.
When you make a mortgage payment, the total amount is typically divided between principal and interest, with any additional amounts going towards taxes, insurance, and possibly private mortgage insurance (PMI) or homeowners association (HOA) fees, depending on your loan terms and escrow arrangements.
The proportion of your payment that goes towards principal and interest changes over time, a concept known as amortization. Initially, more of your payment goes towards interest, but as you pay down the principal balance, a greater portion of your payment goes towards reducing the amount you owe.
It’s important to note that the total monthly mortgage payment (including principal and interest) is determined by factors such as the loan amount, interest rate, and term of the loan. You can use a mortgage calculator to estimate your monthly principal and interest payments based on these factors.
Read More: Mortgage, Loan & Basic, Interest Formula