What Is A Mortgage? – Introduction, Types, And More
A mortgage is a loan from a mortgage lender or bank that allows a person to buy a house or property. Although it is possible to obtain loans to cover the total cost of a home, it is more common to get a loan of around 80% of the house’s value.
The loan must be repaid in time. The purchased house serves as security for the money loaned to a person to buy the house.
Types Of Mortgages
The two most common types of mortgages are fixed-rate loans and adjustable-rate loans.
Fixed-rate mortgages offer borrowers a fixed interest rate for a fixed term, usually 15, 20 or 30 years with a fixed interest rate; the shorter the borrower’s repayment term, the higher the monthly rate. Conversely, the later the borrower pays, the lower the monthly repayment amount. However, the longer the loan is repaid, the more interest the borrower pays.
The most significant advantage of a fixed-rate mortgage is that the borrower can be assured that their monthly mortgage payments will remain the same each month for the duration of their mortgage, making it easier to budget for households and avoid unexpected additional charges from others. In addition, even if market interest rates increase significantly, the borrower does not have to make higher monthly payments.
Adjustable-rate mortgages (ARMs) have interest rates that can, and usually do, change during the life of the loan. Increases in market interest rates and other factors cause interest rates to fluctuate, changing the amount of interest paid by the borrower and, therefore, the total monthly payment due. The interest rate is reviewed and adjusted at specific times with adjustable-rate mortgages. For example, the speed can be changed once a year or once every six months.
One of the most popular variable-rate mortgages is the 5/1 ARM, which offers a fixed rate for the first five years of the payment period, and the rate adjusts annually for the loan term.
Mortgage payments are usually monthly and contain four main parts:
The principal amount is the total amount of the loan grant. For example, if a being takes out a $250,000 mortgage to buy a house, the principal amount of the loan is $250,000. Lenders generally like to see a 20% down payment on a home purchase. So if the $250,000 mortgage is 80% of the home’s appraised value, buyers would pay a $62,500 down payment and the total purchase price of the house would be $312,500.
Interest is the monthly percentage that is added to each mortgage payment. Lenders and banks don’t just lend money without expecting anything in return. Interest is the money an investor or bank earns or charges on the money it lends to homebuyers.
In most cases, the mortgage payments include the property tax that the individual must pay as a landlord. Housing taxes are calculate according to the value of the house.
Mortgages also include home insurance, which lenders require to cover damage to the home (which acts as collateral) and its belongings. It also covers special mortgage insurance, which is usually need when someone is putting down less than 20% of the cost of the home. This insurance is plan to protect the lender or the bank in the event of default by the borrower.
CFI is the official provider of the Financial Modeling & Valuation Analyst (FMVA)® global certification program, designed to help anyone become a world-class financial analyst. The following CFI resources help further your financial education:
- the cost of debt
- variable interest rate
- pay interest
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