Basics On How Mortgage Loans Work
Many people dream of buying a home, but not all can afford to pay for one in cash. It is a good thing that in this day and age, banks now offer mortgages or home mortgage loans to allow an average earning individual to purchase a house without breaking the bank.
However, for some, a mortgage loan is probably one of the most burdensome loans they will incur in their lifetime. That is why borrowers should take time to think and understand the way a mortgage loan works to gauge whether or not he is ready to take on the responsibility and obligation, which comes with incurring a mortgage loan.
So, before we decide to take out a loan to buy a house, let us first understand the basics of a mortgage loan. Once you know what a mortgage is and how it works, you can now assess yourself whether you are ready for the next big thing --- taking out a mortgage loan.
What is a MORTGAGE?
According to Webster’s definition, a mortgage is a conveyance of or a lien against property (as for securing a loan) that becomes void upon payment or performance according to stipulated terms. It is among those listed as the most common types of installment loans.
To illustrate, when you take out a loan to purchase a property, let us say a house, for example, the same property you purchased will serve as a guarantee to secure the loan you took out. In other words, when you take out a mortgage, the collateral on loan will be the house. That in case of non-payment of the loan obligation, your home runs the risk of being foreclosed by the bank or the lending institution.
Typically, a mortgage loan is guaranteed or secured by some deed or written instrument containing the terms and conditions of the mortgage loan. Banks are the traditional lenders of mortgage loans. Not only banks but also credit unions, pension funds, and other government agencies offer mortgage loans.
For you to decide which institution you should take out a loan from, you must be keen on the interest rates and the terms they offer. You should compare them and determine which terms and rates you will be comfortable with.
Down payment on Mortgages
The down payment is the amount of money you pay upfront to reduce the burden on your monthly installments. The more money you cash out initially, the lesser interest you will incur in your remaining payments.
Components of Your Monthly Installments
Your monthly installments will generally be composed of the principal, interest, taxes, and insurance costs.
The principal in your installments is the balance of your loan less the down payment divided by the period within which you must pay the loan. In a simpler sense, it is the balance of your loan spread over a period.
The interest is a percentage of the total amount of money you are borrowing. It is the sum of the value of loan multiplied by the interest rate. It is the sum for which the bank is charging you because of the loan.
The taxes are a sum you pay for your property taxes. It is usually placed into an escrow account until they become ripe for payment.
The insurance costs are the amount charged against the borrower for the procurement of insurance to protect the house from hazards such as fire, storm, flood, theft, and other force majeure or fortuitous events that might harm the property. Most banks require borrowers to procure insurance to secure their interest over the property.
With all these taken together, you will pay for what we call an amortization spread over some time. The period is usually spread over fifteen (15) to thirty (30) years.
For a fixed-rate mortgage, the amount of amortization will be similar until the last due date. This type of mortgage is identified as having a fixed rate of interest over the entire life of the loan. However, some mortgages offer fluctuating interest rates. One of them is an adjustable-rate mortgage. This kind of mortgage has a variety of interest rates over a period depending on the market conditions. These are only a few of the different types of mortgages you should be familiar with as they are prevalent in the market.
Banks will look at your credit score. They will look at your credit history and employment history to determine your ability and means to pay the loan. That means if you do not have a stable income and you have an account of late payments over the last two (2) years, chances are you will find it very difficult to be approved for a mortgage loan.
But that does not mean you will never be allowed to qualify for a mortgage loan. You may still get a loan after complying with additional requirements or settling with a higher interest rate.
Buying a house on a mortgage loan is not an easy decision to make. There are lots of things you need to consider. It requires critical decision making and a lot of research. You have to put a lot of thought into it before going forward with the decision. That is why learning how a loan works is a step one should take to help come up with an informed decision.
About the Writer
Karla Lopez is a blogger and aspiring accountant. She loves to read books on accounting, taxation, and economics. Karla also enjoys sharing with readers her take on the economy and finances. She loves to write about her recent adventures in the business world and her ways of dealing with financial situations.