A mortgage is a loan used to acquire or maintain a home, land, or other types of real estate. The borrower agrees to repay the lender over time, typically through a series of regular principal and interest payments. The property is eligible and used as security for the loan.
A borrower must apply for a mortgage loan through their preferred lender and meet several requirements, and should have minimum credit scores and down payments as well. Before they reach the closing phase, mortgage applications undergo a rigorous underwriting process. Conventional and fixed-rate mortgages, for example, are available based on the borrower's requirements.
• Mortgages are loans used to purchase homes and other forms of real property.
• The property itself is a collateral for the loan.
• A variety of mortgage types are available, including fixed-rate mortgage and adjustable-rate mortgages.
• The price of a mortgage depends on the type of loan, the term (such as 30 years), and the lender's interest rate.
• Mortgage rates can vary significantly based on the type of product and the applicant's qualifications.
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How Mortgages Work
Individuals and organizations utilize mortgages to acquire real estate without paying the full purchase price up front. The borrower repays the loan plus interest over a predetermined number of years until the property is paid in full. The majority of conventional mortgages are fully amortising. This means that the regular payment amount will remain the same, but the proportion of principal to interest paid with each payment will vary over the life of the loan. Standard mortgage terms are 15 or 30 years.
Mortgages are also known as property liens and property claims. If the borrower fails to make mortgage payments, the lender has the right to foreclose on the property.
A residential homebuyer may, for instance, pledge their home to their lender, who then has a claim on the property. This protects the lender's interest in the property in the event that the buyer defaults on a financial obligation. In the event of a foreclosure, the lender may evict the occupants, sell the home, and use the proceeds to settle the mortgage debt.
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The Mortgage Process
Beginning the process, prospective borrowers submit an application to one or more mortgage lenders. The lender will request evidence of the borrower's ability to repay the loan. This could include bank and investment statements, recent tax returns, and employment verification. Typically, the lender will also conduct a credit check.
If the application is approved, the lender will offer the applicant a loan up to a certain amount at a specified interest rate. Pre-approval is the process by which homebuyers can apply for a mortgage either after they have selected a property to purchase or while they are still searching for one. In a competitive housing market, pre-approval for a mortgage can give buyers an advantage because sellers will know they have the funds to support their offer.
Once a buyer and seller reach an agreement on the terms of a transaction, they or their representatives will meet at a closing. This is when the borrower pays the lender the down payment. The seller will transfer ownership of the property to the buyer as well as receive the agreed-upon payment, while the buyer will sign any outstanding mortgage documents. At the closing, the lender may assess origination fees (sometimes in the form of points).
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Types of Mortgages
There are numerous varieties of mortgages. 30-year and 15-year fixed-rate mortgages are the most prevalent options. There are mortgages with terms as short as five years and others with terms of 40 years or more. Stretching out payments over a longer period of time may reduce the monthly payment, but it increases the total interest paid by the borrower over the life of the loan.
Numerous types of home loans, such as Federal Housing Administration (FHA) loans, U.S. Department of Veterans Affairs (VA) loans, and, U.S. Department of Agriculture (USDA) loans are available for specific populations that may lack the income, credit scores, or down payment required for conventional mortgages.
Here are a few examples of the most common types of mortgage loans available to borrowers.
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Fixed-Rate Mortgages
Standard mortgages are fixed-rate loans. With a fixed-rate mortgage, both the interest rate and the borrower's monthly payments remain constant for the duration of the loan. Fixed-rate mortgages loans are also known as conventional mortgages.
Adjustable-Rate Mortgage (ARM)
The interest rate on an adjustable-rate mortgage (ARM) is fixed for an initial term, after which it fluctuates periodically based on the prevailing interest rate. The initial interest rate is frequently lower than the market rate, which can make the mortgage more affordable in the short term but potentially less affordable in the long term if the rate rises significantly.
The maximum amount the interest rate can increase each time it adjusts and over the life of the loan is typically capped for ARMs.
A 5/1 adjustable-rate mortgage is an ARM with a fixed interest rate for the first five years, followed by annual rate adjustments.
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Interest-Only Loans
Other, less common types of mortgages, such as interest-only mortgages and payment-option adjustable-rate mortgages, can have complex repayment schedules and are best suited for borrowers with considerable financial expertise. These loans may feature a balloon payment at the conclusion.
During the housing bubble of the early 2000s, many homeowners with these mortgages ran into financial difficulty.
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Reverse Mortgages
Reverse mortgages are, as their name suggests, a very unique financial product. They are designed for homeowners 62 and older who wish to convert a portion of their home's equity into cash.
These homeowners can borrow against the value of their home and receive the funds in the form of a lump sum, a fixed monthly payment, or a line of credit. The entire loan balance is due upon the borrower's demise, permanent relocation, or sale of the property.
Within each type of mortgage, borrowers can purchase discount points to lower their interest rate. Points are essentially an upfront payment that borrowers make in exchange for a lower interest rate over the life of the loan. For a true apples-to-apples comparison, ensure that you are comparing mortgage rates with the same number of discount points.
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Average Mortgage Rates (Till 2022)
The cost of a mortgage depends on its type (such as fixed or adjustable), its term (such as 20 or 30 years), any discount points paid, and the prevailing interest rate. Interest rates can fluctuate from week to week and lender to lender, so it pays to comparison shop.
In 2020, mortgage rates reached near-record lows, with an average 30-year fixed-rate mortgage rate of 2.66 percent for the week of December 24, 2020.
5 Since the 3rd of December in 2021, interest rates have been steadily climbing . As of July 2022, the Federal Home Loan Mortgage Corporation reported the following average interest rates:
• 30-year fixed mortgage rate: 5.30 percent
• Fixed-rate mortgage for 15 years: 4.45%
• 5/1 adjustable-rate mortgage: 4.19%
How to Compare Mortgages
Once upon a time, banks, savings and loan associations, and credit unions were the only sources of mortgages. Nonbank lenders such as Better, loan Depot, Rocket Mortgage, and SoFi now account for a growing portion of the mortgage market.
An online mortgage calculator can help you compare estimated monthly payments based on the type of mortgage, the interest rate, and the size of the down payment you intend to make. Additionally, it can help you determine how expensive a home you can afford.
In addition to the mortgage principal and interest, the lender or mortgage servicer may establish an escrow account to pay local property taxes, homeowners insurance premiums, and other expenses. These expenses will increase the monthly mortgage payment.
Also, keep in mind that if you obtain a mortgage with less than a 20% down payment, your lender may require you to purchase private mortgage insurance (PMI), which is an additional monthly cost.
With a mortgage, you continue to own your home (and not the bank). Your bank may have provided you with a loan to purchase a home, but instead of owning the property, they have placed a lien on it (the house is used as collateral, when the loan goes into default). However, if you default on your mortgage and it is foreclosed, the bank may become the new owner of your home.
Why do people need mortgages?
Typically, the price of a home exceeds the amount of money most households save. Consequently, mortgages enable individuals and families to purchase a home with a relatively modest down payment, such as 20% of the purchase price, and a loan for the remaining amount. The loan is then secured by the property's value in the event the borrower defaults.
Can anybody get a mortgage?
Prospective mortgage borrowers must be approved through an application and underwriting process. Only those with sufficient assets and income in relation to their debts are eligible for a mortgage loan. When deciding whether to extend a mortgage, a person's credit score is also considered. Also variable is the mortgage's interest rate, with riskier borrowers receiving higher rates.
Mortgages are available from a variety of lenders. Frequently, banks and credit unions offer home loans. There are also mortgage companies that deal exclusively in home loans. You may also hire an independent mortgage broker to help you find the best rate among various lenders.
What is the difference between fixed and variable mortgage rates?
Numerous mortgages have fixed interest rates. This means that the rate will remain the same for the entire term of the mortgage, typically 15 or 30 years, regardless of future changes in interest rates. A variable or adjustable-rate mortgage (ARM) has an interest rate that fluctuates based on the movement of interest rates over the life of the loan.
Subprime Mortgage versus Prime Mortgage
A subprime mortgage carries a higher rate of interest than a prime mortgage. Prime mortgage interest rates are the rates where the banks and other mortgage lenders are willing to lend money to borrowers with the best credit histories. Prime mortgages may have fixed or adjustable interest rates.
How many mortgages am I allowed to hold on my home?
Prior to approving a second mortgage, lenders typically issue a first mortgage. This second mortgage is commonly referred to as a home equity loan. The majority of lenders do not offer second mortgages secured by the same property. There is technically no limit on the number of junior loans you can have on your home, provided you have sufficient equity, debt-to-income ratio, and credit score to qualify.
Why is it known as a mortgage?
The origin of the word "mortgage" is Old English and French, where it means "death pledge." This is so because this type of loan "dies" when it is repaid in full or if the borrower defaults.
The Bottom Line
Mortgages are a necessary component of the home-buying process for the vast majority of borrowers who do not possess hundreds of thousands of dollars in liquid assets. There are various types of home loans available, regardless of your circumstances. Various government-backed programs enable more individuals to qualify for mortgages and realize their dreams of home ownership.
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