Do you really know what is a mortgage? If you are shopping for a home or maybe considering refinancing your mortgage, understanding what is a mortgage is important. Simply put, a mortgage is a legal financial document you agree to when you purchase or refinance a home. It is the payment you make to pay back the loan for your home. But we will explain the ins and outs of a mortgage. This will put you on the best track to getting a great mortgage for your dream home.
The word “mortgage” is actually derived from the latin word “mort”. This means death. The thought behind this word origin is that a mortgage loan will last you a lifetime. But really, what is a mortgage?
A mortgage, or sometimes referred to as a deed of trust, is a legal agreement between the purchaser and a financial institution who is lending the money to make the purchase. Essentially, the lender (which can be a bank, credit union or other financial institution) is buying the home or property on your behalf. Then, over the length of your loan, you make payments to repay the lender.
The mortgage loan is secured by the home or piece of property. In other words, it provides the lender the right to take the property if you don’t repay the loan as agreed. A copy of the mortgage document is filed in the county records of the town or city. It is considered a lien, or legal claim, against the home. Once you have paid off your mortgage, that lender has no further right to the property.
A mortgage is a complex agreement. Like all contracts, there are many terms and conditions. Examples of the terms include:
Length of loan
Most commonly a mortgage term is 30 years. Shorter-term mortgages will allow you to pay off your loan quicker and with less interest, but the monthly payments are higher. Longer-term loans mean a lower monthly payment, but recognize that you will be paying more in interest.
The rate you pay is a large consideration of the agreement. It is the money you are paying in exchange for the loan. You may consent to a fixed interest rate which is a set amount. You may have an adjustable rate that changes depending on the market. An adjustable rate can go up or down. Some mortgages are a hybrid and have an interest rate that is fixed for a certain period of time and then adjusts.
Some mortgage loans require zero down payment and others will ask for more. Make sure you put down as much as you can afford in order to pay less overall in the life of the loan.
Your monthly payment will be outlined in your mortgage document. This will include the principal payment, interest, taxes, and insurance. We’ll explain more on this below.
Alongside the mortgage, you will also sign a promissory note which is a promise that you will repay the money you’ve borrowed, with interest.
Aside from the actual legal document, the term mortgage can also refer to the actual loan itself. Each month, you’ll be required to make on-time regular payments until the balance of the loan is paid off.
A mortgage loan can include:
Principal – your original loan amount minus payments you’ve made
Interest – the interest rate is the cost of the loan. It’s the amount you’ll pay the lender for lending you the money
Taxes – such as property taxes may be included in your mortgage payment so that the lender can pay on your behalf. Sometimes this money is kept in an escrow account until your taxes are due.
Homeowners insurance – this covers damages to your home from fire, accidents, and natural disasters. It is usually required by lenders and collected with your mortgage payment. Like taxes, money for homeowner’s insurance is often held in escrow until the insurance is due.
Mortgage insurance – you may be required to pay mortgage insurance if your down payment was less than 20%. This protects the lender should you default on the mortgage loan. Sometimes it is private mortgage insurance, (PMI) and other times it’s a different type of insurance for government loans like FHA loans.
The act of you making regular payments to your mortgage is call amortization.
While the basic concept of a mortgage is simple, because there are so many options is where there is complexity. There are several types of mortgage products out there with varying eligibility requirements and terms. Some common types include:
Conventional loans are the most common type of mortgage. They do require a higher credit to debt-income ratio than some other mortgage loans. Down payments generally fall between 3%-20%.
The U.S. government issues a variety of mortgages including USDA Loans, FHA loans, and Veteran loans. USDA (U.S. Department of Agriculture) loans are designated for rural properties. They require no downpayment but require mortgage insurance premiums. FHA (Federal Housing Administration) mortgages are easier to qualify for and ask for as low as a 3.5% down payment. Like the USDA loans, they require you to pay a premium for mortgage insurance. A VA (Veteran) loan is only available to military families. They require no down payment and no mortgage insurance.
Here, the borrower’s monthly payments begin low and become much larger over time. They benefit people who expect to have a higher income as they approach the end of their loan.
Sometimes known as a junior lien, is a loan on a home that already has a first mortgage. Like the primary mortgage, a second mortgage uses the home as collateral. Examples of second mortgages include home equity loans and home equity lines of credit.
If you miss your mortgage payments on your home, this is called default. Because of the mortgage agreement, lenders are permitted to take back the home, referred to as foreclosure. Make sure as you are shopping for a mortgage you understand what you are agreeing to.
Take the time to shop around for different mortgage products and different lenders. You will find differences in fees, closing costs, mortgage insurance, down payments and even the interest rates. It’s important to take the time to get several quotes before deciding.