Understanding mortgage loan basics is essential when you are considering buying a home. Mortgage loan basics include an understanding of what a mortgage is, how it differs from standard loans, and the types of mortgage loans available. In America, the vast majority of homeowners buy their homes with a mortgage, and there are numerous different options and lenders, so getting an understanding of mortgage loan basics is crucial.
Mortgage Loan Basics
The first thing most homeowners need to understand about a mortgage is how it differs from other traditional loans. A mortgage loan differs from other debt, such as credit card debt or personal loans, because it is a secured loan. This means there is collateral that backs up the loan, or an asset that the lender can seize if you do not pay. In a mortgage loan, the home serves as collateral. This means the lender holds title to the property and has primary rights to it. A lender can foreclose or take possession of the property if you fail to pay, just as a lender can repossess your car if you fail to pay your car loan.
Mortgage loans are used to purchase existing homes or properties. A mortgage can be used by individuals to buy a home, condominium or co-op. Businesses and not-for-profit organizations can also use mortgage loans to purchase commercial or industrial buildings. Generally, mortgages are only available for properties that already exist. Mortgages are not available for the construction of a new home or for the development of land, which are usually covered by new construction loans and land loan programs.
Types of Mortgage Loans
A fixed rate term mortgage has long been the standard type of mortgage loan. Under a fixed rate, you agree to pay a certain amount per month for a set period of time, until your loan is paid off. The interest you are charged for the duration is fixed at the beginning, and your payments do not change for the entire term unless you refinance or pay off the loan early. Ten year, fifteen year, twenty-five year, and thirty year terms are common. In recent years, forty and fifty year terms have also been made available to allow people to purchase homes with lower monthly payments.
Other financing structures exist and are often considered alternative financing. These payment structures include adjustable rate mortgages, hybrid mortgages, interest only mortgages, balloon payments, or hybrid mortgages. Adjustable rate mortgages do not offer a set interest rate, but instead the interest rate is tied to an index- such as the LIBOR index- and adjusts periodically. Hybrid mortgages are a cross between a fixed rate and an adjustable rate mortgage; they offer a low fixed rate for a set period, after which the interest rate converts to an adjustable rate for the duration of the loan. Balloon payments offer you a set interest rate for a term, usually five to seven years, after which the full balance of the mortgage becomes due and you are expected to refinance to pay off the balance. Finally, under an interest only mortgage, you pay interest payments only for a set period of time and your principle does not get reduced.
Most buyers select alternative financing if they anticipate moving in a short period of time, if they believe interest rates will go down, or if they want to get into a house that they can’t quite afford at the time. Alternative financing can provide you with a good opportunity to get into a home for less, but can be risky if property values fall.
Other Mortgage Loan Basics
Mortgage interest rates vary greatly based on down payment amount, credit rating, lending institution, and broker or agent judgment. A traditional mortgage requires the buyer to put at least twenty percent of the purchase price down at the time of closing. If the buyer puts less than twenty percent down on the property, additional fees called private mortgage insurance may be assessed.
While these mortgage loan basics provide a brief overview of mortgages, it is essential that you do proper research before agreeing to a mortgage. Comparison shop for lenders, read contracts fully, and ensure that you have fully evaluated the mortgage loan basics associated with your particular loan before committing to a mortgage.
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