A mortgage is a specific type of loan employed for the acquisition or maintenance of a home, land or other real estate forms. The borrower commits to reimbursing the lender over an agreed period, with payments typically divided into principal and interest components. In this arrangement, the property acts as collateral, securing the loan.
To obtain a mortgage, a borrower applies through their chosen lender, ensuring they meet various requirements, including minimum credit ratings and down payments. Mortgage applications undergo a stringent underwriting process before reaching the closing stage. The type of mortgage selected depends on the borrower’s needs, with options such as conventional and fixed-rate loans.
Understanding Mortgages
Mortgages enable individuals and businesses to acquire real estate without upfront full payment. The loan, along with interest, is paid back over a specified period until the borrower fully owns the property. Payments in traditional mortgages are fully amortized, meaning the regular payment amount remains the same, but the principal versus interest proportion varies with each payment over the loan’s life. Mortgages are typically set for 30 or 15 years.
Mortgages essentially represent liens against or claims on properties. If the borrower ceases mortgage payments, the lender can foreclose on the property. For example, in residential real estate transactions, a homebuyer offers their property as collateral to the lender, who subsequently secures a claim on the said property. This arrangement safeguards the lender’s interest in the property should the buyer default on their financial commitment. In foreclosure, the lender can evict the tenants, sell the property, and utilize the sale’s proceeds to settle the mortgage debt.
The Mortgage Process
Prospective borrowers initiate the process by applying to one or more mortgage lenders. The lender, in turn, requests proof of the borrower’s ability to repay the loan, such as bank statements, investment records, recent tax returns, and confirmation of current employment. Usually, the lender also conducts a credit check.
If the application is successful, the lender proposes a loan to the borrower up to a specific amount and at a particular interest rate. Homebuyers can apply for a mortgage after selecting a property or during the search, a process known as pre-approval. Pre-approval can provide a competitive edge in a tight housing market as sellers are assured that the buyers have financial backing.
Upon agreement on the deal’s terms, the buyer and seller, or their representatives, convene for a closing. Here, the borrower pays the down payment to the lender, the seller transfers the property’s ownership to the buyer and receives the agreed sum. The buyer then signs any remaining mortgage documents. The lender may impose origination fees (sometimes in points form) at the closing.
Types of Mortgages
Mortgages come in diverse forms, with 30-year and 15-year fixed-rate mortgages being the most common. Some mortgage terms are as brief as five years, while others can extend to 40 years or more. Spreading payments over a longer period may lower the monthly payment, but it increases the total interest paid throughout the loan’s life.
Among the various term lengths, numerous home loan types exist, such as Federal Housing Administration (FHA) loans, U.S. Department of Agriculture (USDA) loans, and U.S. Department of Veterans Affairs (VA) loans. These are available for specific groups who may not meet the income, credit scores, or down payment requirements for conventional mortgages.
Here are a few prevalent mortgage loan types:
Fixed-Rate Mortgages
The fixed-rate mortgage is standard. Here, the interest rate and the borrower’s monthly payments remain constant for the loan’s entire term, hence the alternative name traditional mortgage.
Adjustable-Rate Mortgage (ARM)
An ARM features an interest rate that remains fixed for an initial term, after which it can periodically change based on prevailing interest rates. The initial interest rate is often below-market, making the mortgage more affordable short-term but potentially less so long-term if the rate significantly rises. ARMs usually have caps on how much the interest rate can increase each time it adjusts and over the loan’s life.
Interest-Only Loans
Less common mortgage types, such as interest-only mortgages and payment-option ARMs, come with complex repayment schedules and are best suited for sophisticated borrowers. These loans may include a hefty balloon payment at their end. Such mortgages led many homeowners into financial difficulties during the early 2000s housing bubble.
Reverse Mortgages
As the name implies, reverse mortgages are a distinct financial product. They are designed for homeowners aged 62 or older looking to convert part of their home equity into cash. Borrowers can draw against their home’s value and receive funds as a lump sum, fixed monthly payment, or credit line. The entire loan balance is due when the borrower dies, permanently moves away, or sells the home.
Average Mortgage Rates in 2022
The mortgage cost depends on the mortgage type (fixed or adjustable), its term (20 or 30 years), any discount points paid, and prevailing interest rates. Interest rates fluctuate weekly and differ among lenders, so shopping around is advisable.
Mortgage rates hit near-record lows in 2020, bottoming out at an average 2.66% on a 30-year fixed-rate mortgage for the week of Dec. 24, 2020. Rates remained stably low throughout 2021 and began a steady climb from Dec. 3, 2021 (see the chart below). As of July 2022, average interest rates were as follows, according to the Federal Home Loan Mortgage Corp.
Comparing Mortgages
In the past, the mortgage market was predominantly dominated by banks, savings and loan associations, and credit unions. Today, nonbank lenders, including Better, loanDepot, Rocket Mortgage, and SoFi, constitute an increasing share of the mortgage market.
When shopping for a mortgage, an online mortgage calculator can help compare estimated monthly payments, based on the mortgage type, interest rate, and down payment size. It can also assist in determining an affordable property price.
Besides the principal and interest payable on the mortgage, the lender or mortgage servicer may establish an escrow account to pay local property taxes, homeowners insurance premiums, and certain other costs. These expenses add to your monthly mortgage payment.
Also, if you make less than a 20% down payment when securing your mortgage, your lender may require that you purchase private mortgage insurance (PMI), which becomes an additional monthly cost.
Why People Need Mortgages?
Home prices are often significantly higher than what most households save. Hence, mortgages enable individuals and families to buy a home by making a relatively small down payment, such as 20% of the purchase price, and securing a loan for the balance. The loan is then backed by the property’s value in case of borrower default.
Can Anyone Obtain a Mortgage?
Mortgage lenders must approve potential borrowers through an application and underwriting process. Home loans are only granted to those whose assets and income relative to their debts make it feasible to sustain a home’s value over time. A person’s credit score is also considered when deciding to extend a mortgage. The interest rate on a mortgage is not static; it fluctuates based on the borrower’s risk profile, with higher rates assigned to those perceived as riskier.
Mortgages are offered by various sources. Banks and credit unions often supply home loans, and specialized mortgage firms deal exclusively with home loans. You can also use an independent mortgage broker to help find the best rate among different lenders.
What Does Fixed vs. Variable Mean on a Mortgage?
Many mortgages feature a fixed interest rate, meaning the rate remains unchanged for the mortgage’s entire term—typically 15 or 30 years—even if future interest rates rise or fall. A variable or adjustable-rate mortgage (ARM) has an interest rate that varies over the loan’s life based on current interest rates.
Exploring Home Ownership: How Many Mortgages Are Allowed on a Single Property?
Typically, lenders grant a primary or first mortgage prior to sanctioning a secondary mortgage. This additional mortgage is often referred to as a home equity loan. Most lenders do not permit a subsequent mortgage backed by the same property. Technically, there is no limit to how many junior loans you can have on your home, provided you have the equity, debt-to-income ratio, and credit score to get approved.
Why is it Called a Mortgage?
The term “mortgage” originates from Old English and French, meaning “death pledge.” The loan “dies” when it is fully repaid or if the borrower defaults.
In Conclusion
Mortgages are a crucial element of the home buying process for most borrowers, lacking hundreds of thousands of dollars in cash to outright buy a property. Various home loan types cater to different circumstances. Different government-backed programs enable more people to qualify for mortgages, bringing home ownership dreams to life.