Ever wonder what exactly is a mortgage. Here are some of the basics.
What is a mortgage?
A mortgage is simply a debt instrument, or even more simply a loan that is taken to buy land or property.
- It is an obligation for the borrower to pay it back within a span and through a predetermined set of payments.
- Since the value of the loan that your receive is secured against the value of the property that you are buying, in case you are unable to pay it back, the lender becomes authorized to repossess it and sell it off to recover the payment.
- This period begins from 10 years to 50 years maximum. Apart from the principal amount of the mortgage, you also have to pay an interest every month.
- Once this repayment is made in full and final, the borrower becomes the owner in the real terms of ownership.
- This is why the mortgage is also called “claims against property.”
- When you take a residential mortgage, that particular house has to be pledged to the bank or the lender.
- If you become a defaulter of payment, the bank will claim the house.
- And so, if the bank decides to foreclose, it is authorized to evict the inhabitants, even if tenants and sell the house off to clear the mortgage debt.
Scary, as it may sound, a mortgage can be totally safe if you have your good credit and the ability make the monthly payments.
What are the Different Type of Mortgages that You May Choose?
There are some mortgage types to choose from though there are only a chosen few that are most popular with the American borrowers.
FRM or the Fixed Rate Mortgage
This type is the most popular with the conventional 15-30 year fixed interest plan. With this one, the borrower pays the same interest rate throughout the span of the loan. The monthly principal and interest amount stay unchanged even if the market interest rates rise or fall. In case they fall, the mortgage may be changed at the discretion of the borrower.
ARM or Adjustable Rate Mortgage
Also known as Adjustable Rate Loan, Variable Rate Mortgage, and Variable Rate Loan, this kind offers lower rates of interest and monthly payments than FRM. However, the risk here is that if the rates rise, they become expensive. It can happen so because its interest rate is based on one year Treasury Bill yield. So, if the Treasury Bill rises all of a sudden, the ARM rate will change and make it more expensive.
Interest Only Loans:
It is a kind of ARM. This mortgage provides super-low payments. It starts with being an AMR for the first 5 or 10 years; later, i.e. for the rest of the stipulated term the balance is amortized. In simpler words, the first 5 or 10 years will be interest-only, and for the latter part, it would be a conventional mortgage
Here, the borrower has the option of choosing as to what type of payment he/she wishes to make to the lender. Not only do you have the prerogative of determining the kind of payment and interest rate but also of making smaller payment either by picking minimum payments or interest-only payments.
Herein, when the payments made fail to cover the interest rate that is due, the balance of that interest amount is added to the principal amount. It implies that if you have ended up paying lesser interest than is due, your capital becomes more expensive, and you owe even more.
Ultra-Long FRM or 50 Year Mortgage
It is a conventional mortgage that lasts for 40 to 50 years which means you get to pay them off during this span. Because it is so long-term, the monthly payments of principal and interest come to be pretty small. They are mostly used as cash flow and usually don’t get stretched beyond 50 years.
This one does not fully amortize over its stipulated span and thus, what is left behind is a balloon or a large-sized balance payment at maturity. This one-time payment has to be made at maturity. This mortgage is so very typical of residential as well as commercial real estate.
This balloon payment usually amounts to more than twice the average monthly payment of the loan.
Zero Money Down Mortgage
This is a risky option for those who do not wish to make a down payment for the property. I may sound like a brilliant idea, but one must think well about it for it has more cons than pros. They allow you to buy a house without making any down payment, but this mortgage is not very readily available; has a lot of conditions, and may even turn out to be a bad choice.
What if You Have a Low Credit Score?
It would be only foolhardy to think that your credit score wouldn’t interfere with your mortgage. It has a significant bearing on any mortgage that you may wish to apply for, and with a bad score, there could be situations when your application may be turned down.
Also, just because your credit score doesn’t conspicuously state that it is bad, doesn’t mean it is eligible for just any mortgage. If your score is anything between “fair” to “poor”, you may have to look harder for a mortgage.
If you roughly rate anything between 850 and 350, you are considered creditworthy. The higher you will go, more the lenders will be ready to offer a mortgage. Scorers with 720 and higher have the best choices for terms and rates of interest.
This is how your credit will be evaluated:
- 720 and above – Excellent
- 660 to 719 – Good
- 620 to 659 – Fair
- 619 and below – Bad/poor
Those lying in the “fair” to “bad” range, you may look for a loan from government-insured Federal Housing Administration. However, at present, lenders are becoming less stringent about credit scores and are willing to differentiate between candidates who are irresponsible and the ones who may have got sacked.
You could also try for a mortgage by putting more money down, searching for other non-conventional loans or consult a home ownership counselor. If not that, then probably, you could just wait, get your credit right in due course of time and apply when you have crossed the 620 mark.
Which is the Best Mortgage for You?
Though it may depend on your paying trend and capacity that plays a decisive part in determining what the best mortgage for you is, yet is the conventional 30-year FRM that is the most popular. Right sine the year 1999, it makes up for 70-90% mortgages in the US.
Its cousin, the 25-year FRM has also been quite popular. The only drawback is that even if the interest rate falls, you end up paying same as you had been.
People do opt for ARM or variable rate mortgages. Some do benefit from it. But it could be a gamble. If the interests shoot up, you need to pay mush more than what you expected.
Most first-time buyers go for FHA loans because of low minimum down payment, reasonable credit expectations, and more flexible income requirements. But that is mostly for first-time buyers. Not all mortgagors are eligible for these.
How Much Mortgage Can You Afford?
It is really not about the lender calculation how much you can repay. For that matter, even mortgagee won’t consider your incoming flow before the mortgage value and payments can be decided upon.
The bitter truth is that we tend to overreach and think we can repay more than possible before a mortgage is underwritten. It is important to consider all your monthly and contingent expenses well in advance. Things like taxes, insurance, maintenance, household expenses should not for foregone when you calculate a mortgage payment.
And this is why you need to provide the lender with all the proofs of your income, expenditures, as well as debts. Also, in case you are opting for an ARM, you will need to prove that you will be able to repay in case the interest rate rises.
Do You Require Mortgage Insurance?
Mortgage Protection Insurance (MPI) and Private Mortgage Insurance (PMI) are two different things. As the confusion goes MPI or MPPI (mortgage payment protection insurance), people believe that it pays off your mortgage in case of death, disability or loss of a job. However, it has nothing to do with any of these events. It just pays off your mortgage in case of foreclosure. And, as made mandatory by law, you need to get PMI if your down payment is less than 20% of the value of your purchased home.
Where to Get a Mortgage?
This is no rocket science, though; you still need to think about it. You can either apply for it directly to a bank or to building society. You can also consider a broker or an IFA – independent financial adviser who can tell you the pros and cons and give you a perspective and terms that direct borrows may be devoid of. Look at originators such as Freedom Mortgage Retail Lending or a local savings and loan.
How does a Mortgage Work?
Taking the Mortgage
This is no rocket science either. You borrow money from a lender. This money is called the capital. In lieu of that, the mortgagee charges interest on it till you pay it back in full. This helps you buy a property and keep paying for it gradually.
Repaying the Mortgage
As already discussed above, the number of payments, the time span, and the interest rate depend on the kind of mortgage you are opting for. You need to do this every month for the span stipulated by the terms.
In case you fail to repay this value, you end up with a foreclosure by the lender, wherein your property will be repossessed and sold off to recover the mortgage payment.
Do Mortgages Enjoy a Tax Advantage?
It may do that for you in some cases. To be a beneficiary of mortgage tax benefit, there are several things that you need to know, including what is considered as mortgage interest. Contact your estate planner to understand the tax and other financial implications of a home mortgage.
Mortgage interest is deemed to be any interest paid a loan secured by the main home or a second home. These loans include a home equity loan, a line of credit, and mortgage to buy your home or a second mortgage. In case the loan is not secured by your home, it is, by all means, a personal debt. And so will not be eligible for any deduction. Also, if it is for a third or a fourth home, it is not mortgage interest either.
If you have bought a house, condominium, cooperative home, mobile home or a similar accommodation that has sleeping, cooking and toilet facility, it is called a home, and the mortgage interest thereof is considered for a tax deduction. As a primary borrower, you can reap the benefit.
So, gauge all the possibilities of a mortgage before you take one so that it becomes an asset rather than a liability.