Basics of Mortgages

mortgage papers

What is a mortgage? A mortgage is a loan that you receive from a bank or mortgage lender in order to purchase a house. When you get a mortgage, you put up your home as collateral. This means that if you fail to make your payments, the bank or lender has the right to foreclose upon the house. Essentially, the borrower possesses the home, but the lender is the one who owns it until the full amount of the mortgage is paid off.

Monthly mortgage payments include the principal, interest, taxes and insurance.

Principal

The principal is the total amount of money that was borrowed to purchase the home. For example, if you borrow $200,000, then the starting principal will also be $200,000.

Interest

Interest is the additional price that you pay to a lender for borrowing money. The interest on your mortgage can either be fixed or variable. A fixed rate mortgage is a loan that charges a set interest rate that does not change throughout the term of the loan. A variable rate mortgage (also known as an adjustable rate mortgage) is a loan in which the interest rate is subject to change.

Taxes

As a homeowner you have to pay property taxes. These taxes are typically calculated based on the value of your home, and varies by state.

Mortgage Insurance

You are required to get homeowner’s insurance by your lender. This covers your house and sometimes the property inside. For a conventional mortgage, if your down payment is less than 20%, your lender will require mortgage insurance. This protects the lender if you default on your loan.

Amortization Schedule

An Amortization Schedule is a complete table of periodic loan payments that shows the amount of principal and the amount of interest that make up each payment, assuring that the loan will be paid by the end of its term. Early in the schedule, your payments will primarily go towards your interest. Later in the schedule, a majority of the payment will be put towards the principal.

Mortgage Note

A mortgage note is a legal document that you will sign when you get a mortgage. It states that you promise to pay the balance of your mortgage with interest and any other agreed upon variable costs over a set period of time (usually 15 or 30 years). It also states that if you default on your loan, the lender is allowed to foreclose upon the property and sell it.

Eligibility

It’s important to remember that just because you qualify for a loan, doesn’t mean that you can necessarily afford the property. Loan eligibility is based on a formula– your monthly mortgage loan payment shouldn’t exceed 28% of your gross income (your income before accounting for taxes or deductions). If you have a good credit history, your lender may allow your monthly payment to be as high as 40% of your gross income. However, this is something you should consider carefully– it isn’t a good idea to bite off more than you can chew when it comes to home buying.

Types of Mortgages

Your two major options are Fixed Rate Mortgages and Adjustable Rate Mortgages (ARMs). With a fixed rate mortgage, your monthly mortgage payment stays the same for the duration of your loan. With an ARM, your mortgage rate (and therefore your monthly payment) will stay the same for a certain amount of time, before becoming adjustable. Your mortgage payments in an ARM will change according to an index. For more information on Fixed and Adjustable Rate Mortgages, take a look at the links at the beginning of this section.

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