What is a Mortgage



What is a Mortgage?

A mortgage is a legal document giving a lender a lien on real estate to secure repayment of a loan. A mortgage loan is used to buy or refinance a house. The house is collateral for the mortgage loan.

To pay off a mortgage, you make monthly mortgage payments. Your monthly payment is usually divided into four parts: Principal, Interest, Taxes and Insurance (PITI). For the first half of your loan term, most of your payment is applied to interest. Some loans also include payments for private mortgage insurance.

Types of Loans

There are many different types of mortgage loans. Most borrowers choose a 30-year term, but loans are also available in 15-, 20- and 25-year terms.

Fixed-Rate Mortgage

A fixed-rate mortgage is stable because the interest rate is set for the term of the loan and you make the same monthly payment of principal and interest for the life of the loan. This stability makes it easy to plan a budget and manage your finances.

Adjustable-Rate Mortgage (ARM)

An ARM usually starts with a lower interest rate than a fixed-rate loan. After the initial period, which ranges from 6 months to 7 years, the rate will adjust up or down annually (or semiannually) for the life of the loan based on a specified index. Your monthly payment changes as the index changes. The ARM features a lifetime cap, which is determined at the time you lock in your interest rate. You know from the start the maximum rate on your loan.

Pre-Qualified vs Pre-Approved

Pre-qualification is an informal estimate of how much of a home you can afford. It is based solely on what you verbally tell the lender about your income and debt obligations. The lender does not verify any information and does not provide a written letter stating the amount of money you’re qualified to borrow. There are no fees involved with pre-qualification.

It’s a good idea to go a step further and get pre-approved. When you get pre-approved, you are actually beginning the loan application process. This means the lender will verify your credit rating, employment history, income and assets. Once your offer on a home is accepted, final approval of your loan can be completed more quickly, since your financing has already been arranged. Please note the lender will put your pre-approval in writing. Some lenders may charge pre-approval fees.

Rates and Points

As you shop for mortgages; you may see two similar types of rates: mortgage interest rate and annual percentage rate (APR). It is important to understand the difference between them.

The interest rate is the cost for the use of a loan. It is usually expressed as a percentage of the loan, paid over a specific period of time. The interest rate does not include fees charged for the loan. Unlike your interest rate, the APR includes other charges, such as the origination fee, to reflect the total cost of the loan over the life of the loan.

Your monthly mortgage payment (principal and interest) is calculated on the mortgage interest rate - not the APR.

Points (also known as discount points) are paid by the borrower to the lender to obtain a lower interest rate. Each point is equivalent to 1% of the loan amount. For example, on a $100,000 loan, one point would equal $1,000. Typically, a borrower can purchase from one-quarter of a point to three points.

Private Mortgage Insurance

If your down payment is less than 20% of the home purchase price, you can expect to pay private mortgage insurance (also known as PMI). With private mortgage insurance, you can buy a home with a lower down payment than the lender usually requires. Two federal agencies, the Federal Housing Authority and the Veterans Administration, provide insurance for some of their mortgage loans.

The cost of private mortgage insurance varies, depending on your down payment and the type of loan you select. It is usually included in your monthly payment, along with principal, interest, and taxes. Private mortgage insurance ensures that the lender is protected in case you default on the loan.

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