Mortgage

An agreement with a lender for a property with scheduled payments for the money borrowed.

A mortgage is an agreement between the lender and borrower where the lender can seize the property if the borrower fails to make scheduled payments that are borrowed. It can be used either to buy a property or borrow against the value of the property you already own.

The word comes from the French Law term 'mortgage' used in Britain in the middle ages, meaning 'death pledge,' which meant that a deal ends when the debt is paid, or payment failed.  

It is useful because only a few of us have enough cash on hand to purchase a home. So instead of paying outright from the pocket, it helps you to have a home more affordably. 

And if you want to sell your home, part of the proceeds can be used to pay off the remaining contract amount due to the lender.

When you take out a loan, you get an amount set by the lender to buy the house or property you desire, where you are liable to pay back the amount borrowed due plus interest over several years. 

The lender's right to your home or property you bought continues until it is fully paid off.

If you have trouble making payments, contact the lender and ask about hardship programs such as forbearance, deferment, or modification. These are supposed to give you temporary relief from charges.

If you still struggle, consider selling the house in a short sale if the circumstances do not improve. 

The parties involved in this agreement are:

  • Lender: The bank or Financial institution that provides you money.
  • Borrower: The person who gets the money.
  • Loan servicer: The party who is responsible for making monthly statements or processing payments and so on.

Types of mortgage

The various types of mortgage are:

Fixed-rate

These types let you pay a fixed interest rate throughout the entire life of the contract. The most commonly used are 15-year or 30-year fixed terms. Also, some lenders offer other terms. 

Well, in the case of other contracts, the economic factors affect the rates, so opting for a fixed one will not affect the rates.

So no matter what happens, from the moment when you secure a credit till the end of it, the rate remains the same.

And If you plan on staying for more than seven years, this is the preferred option to consider.

Adjustable-Rate (ARM)

ARMs are those whose interest rate changes when there is a movement in a corresponding index that is associated with it. For example, the monthly payments go up and down when the index goes up or down. 

ARMs have fixed payments for the first few years that are lower than the average fixed rate being offered during that time and change after the specified period is over. 

If you don't plan to stay there before the initial term is not over, you don't need to be concerned about the rate changes after that.

Government-insured

Even though the Government is not the lender, it plays a good role. And if you don't have a good credit score to get conventional ones, these loans may be availed.

  • FHA(Federal Housing Administration) loan

It is a Government-backed credit insured by the Federal Housing Administration. These loans require fewer credit scores and lower down payment than conventional contracts, which helps first-time buyers.

  • VA loan

A zero-dollar down payment credit is available for veterans, service members, and select spouses. It was created to help returning veterans buy a house without needing a good credit score or down payment.

  • USDA loan

It is also a zero-down payment credit that allows rural households in the US to get lending that offers fewer interest rates and no down payment. This program was designed to help improve the economy and help rural life in America.

Jumbo loan

This kind is used to finance housing properties that are too expensive and can't be considered for a conforming contract. A home that exceeds the local conforming credit limit requires a jumbo contract.

However, they can have stricter requirements than other contracts. For example, you will have to meet a particular property type, down payment, credit score, and debt-to-income ratio.

If you want to purchase a home from a high-price market, you might need a jumbo one. Now, it is easier to get one through an online application.

Interest-only

An adjustable-rate contract allows borrowers to pay only interest for the first few years. It converts to a conventional one after an introductory period of 3 to 10 years.

One of the advantages of these kinds of credits is they have lower monthly payments than the conventional ones. That allows the borrower to afford an expensive home. 

The borrower can pay off Adjustable-rate agreements faster than the other credits and is also very flexible than the other ones. Interest-only contracts can also be called exotic loans.

Average Mortgage Rate(AMR)

Simply put, it is the rate it costs you to finance your property. It is the amount you must pay your lender and the principal amount. For example, if your AMR is 3%, you must pay 3% of the loan balance as interest. 

The difference between AMR and Annual Percentage Rate is that AMR is the percentage of the amount you borrowed, whereas the Annual Percentage rate is based on your interest rate, brokerage fees, and other costs.

When looking at APR vs. interest rate, at its simplest, the interest rate reflects the current cost of borrowing expressed as a percentage rate. However, the interest rate does not reflect fees or any other charges you may need to pay for the borrowed amount.

The APR, also expressed as a percentage rate provides a complete picture by taking the interest rate as a starting point and accounting for lender fees and other charges required to finance the lending.

What is included in a mortgage payment?

The things included in such a payment are:

Principal

It is the amount the borrower has to pay over the contract's life. Most commonly, the borrower takes up to 70%-95% of the selling price of the property.

Property Taxes

These taxes are what the community levies on the percentage of the property's value. Taxing percentages are based on the location of the property.

Insurance

There are two kinds of insurance; homeowner's insurance and Private Mortgage Insurance(PMI).

Homeowner's insurance is a general requirement to get a loan; it ensures the property is against natural calamities, theft, or fire, whereas PMI protects the lender from the default of monthly payments.

Interest

It is the remuneration the lending institution gets to lend the money to you for buying your house. It can be monthly or yearly charged against the amount you borrowed that is to be repaid.

Terminologies Used 

The different terminologies are:

Adjustable-Rate Mortgage(ARM)

It is a type of agreement where the rate changes concerning the market movements; they have a fixed interest rate. It changes due to moves in an index such as Treasury securities or the Cost of Funds Index.

ARMs usually have lower interest rates than fixed interest rate contracts.

Amortization

It is a process that shows how the payments are spread out. It is a repayment feature with equal payments, where a percentage goes down to interest and the rest for the principal.

Annual Percentage Rate(APR)

The percentage includes interest rates, broker fees, and other charges to avail of that credit. There are two types of APR: Representative and personal APR.

Representative APR is based on the advertised annual interest rate on the contract. Personal APR is the interest rate offered to you for the loan based on your profile and eligibility.

Balloon Payment

It's a type of payment where a lump sum amount is paid at some point, usually at the end. A balloon payment is higher than what you usually pay towards the contract.

It may have fixed or floating interest rates.

Conforming loan

A conforming or conventional are loans that meet standards and guidelines of Government Sponsored Entities(GSE) like Fannie Mae or Freddie Mac

These GSEs buy loans from the lenders that meet the guidelines and bundle these loans with similar ones, securitize them and create Mortgage-Backed Securities( MBS).

Debt-To-Income Ratio

The Debt-To-Income Ratio is the measure of the percentage of income that is used for paying the debt and reservicing. 

The ratio calculates all monthly debt repayment divided by your gross monthly income. Individuals with a low debt-to-income ratio are most likely to pay back debts.

Down Payment

A down payment is made at the beginning of the purchase transaction. The primary purpose of it is to ensure that the lending institution has enough funds to finance the agreement in a fractional reserve system and recover some of it if the borrower defaults. 

In the United States, the Down payment varies between 3.5% to 20% of the purchase price.

Escrow

In the US, it is the legal arrangement in which a third party temporarily holds money or property until a specific condition is met, usually a purchase agreement. 

It is used in real estate to protect both buyers and sellers. In addition, this account will hold homeowners insurance and taxes throughout the term of the period.

Foreclosure

It is the process in which a lender attempts to recover the rest of the amount from the borrower who has stopped making payments from selling the property used as collateral.

For our information, the company does not want to foreclose our property because this process is time-consuming and expensive for them.

Mortgage Servicer

It can be a central bank, credit union, community bank, or other financial institution specializing in loan servicing, collecting individual payments, or handling customer service.

The difference between a lender and a servicer is that the lender makes the home loan, and the servicer manages the home credits while the borrower pays them down. 

The primary role of these services is collecting monthly payments and allocating them carefully towards principal, interest, and escrow.

Non-Conforming

Non-Conforming loans don't meet Fannie Mae's or Freddie Mac's standards for purchase. They are mainly considered non-conforming due to not meeting the standards set by FHFA( Federal Housing Finance Agency) or being too big to be considered conforming. 

It is convenient for those who have negative markings in credit and still want to purchase a home or refinance it.

Private Mortgage Insurance(PMI)

Conventional borrowers require PMI; that is, when they buy a home and make a down payment of less than 20% of the purchase price, PMI becomes a part of the payment, so it protects the lender from the default of borrowers.

PMI and Homeowner insurance are different because Homeowner insurance protects the owners from property damage while PMI helps secure credit with less than a 20% down payment.PMI rates vary between .5% to 1% of the agreed amount per year.

Promissory Note

A Promissory Note is an agreement between two parties where one party agrees to pay back an amount given by another party. Lenders use it as a way to ensure there is legal recourse in the event you do not repay the amount. 

A promissory note is a vital piece of an agreement ensuring that a borrower is indebted to a lender for credit repayment.

Underwriting

Underwriting is when a lender checks income, assets, debts, and property details to issue final approval on the loan application. 

An underwriter usually investigates credit scores, Orders an appraisal, verifies your income and employment, checks DTI ( Debt To Income) ratio, and verifies down payment and savings.

Conclusion 

Owning a house can be challenging when inflation rises, and other economic conditions are factors. 

So getting a loan can be helpful for those who want to purchase a home but do not have thousands or millions of dollars. Even though it's a big commitment for many years, it's worth it.

If you work and anticipate all the downfalls that may happen, you can overcome some significant hurdles buyers may face and have a smooth process. 

The only obvious downfall of having it is paying a lot of interest over the years. Although, if you can pay back some of the principal amounts faster, it would decrease the claim to be paid.

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Research and authored by Khadeeja C Abbas  | LinkedIn

Reviewed and Edited by Aditya Salunke I LinkedIn

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