A mortgage is a special type of loan used in buying houses. Like any loan, a mortgage is expected to be paid back over a predetermined period of time with interest. These loans are typically issued by banks. As a mortgage results in a large sum of a house's value being borrowed, (often up to 80%), it is important to understand exactly how they work to avoid taking uninformed risks.
First, it is important to know that if the terms of the mortgage are not met, the issuer of the mortgage has every right to take your home from you using a process called foreclosure.The legal definition for mortgage is "the pledging of property to a creditor as security for the payment of a debt", which means your house is essentially considered collateral for your loan. This means if payments are consistently missed or late, the house will be taken away.
Now that you understand the risks of a mortgage, it is time to look at the finer details. With any mortgage there is a payment required up front, called a down payment, which is required to cover a portion of the initial cost of the house. This amount is usually around 20%, but can sometimes be much lower under certain circumstances. One important thing to remember is that the larger the initial down payment is, the smaller the monthly payments on the mortgage will ultimately be.
Next, we will look at the breakdown of a monthly mortgage payment. Generally speaking, your total expenses in a mortgage will consist of 4 things known by the acronym “PITI”. They are the following:
The principal is the total amount of money borrowed after the down payment is taken into consideration.
The interest is the amount of money charged for borrowed money. This is a percentage of the total principal amount that accumulates gradually over the time that it takes to repay the loan.
The taxes are the set rate of property tax charged on your property.
The insurance is a common cost required by issuers of mortgages to cover potential losses or damages to the house.
When making payments on a loan it is important to understand the concept of amortization which basically means that each payment you make is going to cover part of the principal cost of the loan as well as part of the accumulated interest on the principal cost.
The final thing to know about mortgages is that there are many different kinds and each has its own terms of repayment and other variable details such as interest rates.The two most common types of mortgages and how they work will be described below:
The fixed-rate mortgage is a loan whose interest rate stays the same for the entire life of the mortgage. This means that every monthly payment you make will be roughly the same exact amount until the loan is paid off.
The adjustable-rate mortgage is much different. In an adjustable-rate mortgage, the interest rate changes at a regular interval that is predetermined. This interval is usually 1 year but can be 6 months or several years as well. The appeal in an adjustable-rate mortgage is that the starting interest rate is usually much lower than that of a fixed-rate mortgage.