A mortgage is one of the biggest personal debts that a person will ever accrue. In today’s environment, almost everyone who owns a home also has a mortgage on that home.
What a mortgage is. A mortgage is a word used by lending companies to describe a large chunk of money given to a borrower in order to make a purchase, usually a house. The title to the house actually belongs to the lending company until such time as the initial amount loaned to the buyer is repaid in full to the company.
It is important for anyone getting into the home market to realize that a mortgage is not a gift but a loan. Institutions who lend out money for loans have a vested interest in not only getting the money back, but also making a profit on the service. Therefore, lending companies and other financial institutions who offer mortgages charge interest on the loan. This interest is charged every month on the loan, so that the amount paid for the house is always significantly higher than the price the hose was purchased at.
Amortization
Amortization is the term used to describe the amount of time that a mortgage is in place for. It refers strictly to the amount of time it takes for the borrower to pay off the debt.
Fixed and variable rate mortgages
Mortgages come with two rate options; fixed and variable. Fixed rates mean that the home buyers agree to pay back interest on the loan at the amount currently in place at the time of purchase. The rate is fixed for a certain amount of time, usually five years. During this time, the borrower will only ever be charged the interest that occurred at the time of purchase; their mortgage payments will not be affected by a rise or fall in the rate of interest.
If you purchase a house at %5 interest at a fixed rate for a period of five years, you will always pay 5%. This is the percentage paid whether interest rates rise to 10% or whether they fall to 2.5%. As you can see, there are some risks involved in locking in the interest rates.
Variable interest rates do not lock the buyer in to the interest rate at the time of purchase. Instead, they allow the interest to be paid along with the fluctuations in the market. These rates are usually encouraged when a buyer is making a purchase at a time when the interest rates are high; a variable rate will allow them to lock in when interest rates come down. On the downside, however, variable rates may mean that buyer’s mortgage rates rise so much that they are unpayable in the event interest skyrockets.
Conventional and non-conventional mortgages
In addition to fixed or variable interest rates, mortgages can be classified as either conventional or non-conventional. Conventional mortgages call for a minimum amount to be contributed as a down payment towards the home. In other words, the lending institution will only forward a maximum of 75% of the money towards the purchase. The remainder of the money must be provided by the purchaser up front.
Non-conventional mortgages are when borrower’s put less than 25% down towards the purchase of their home. In the past, non-conventional mortgages were rare and for the most part conventional mortgages were mandatory by law. Since the turn of the century, however, non-conventional mortgages have become the normal way of things, with buyers putting as little as 10% and, recently, even zero dollars down towards the purchase of their homes.
Penalties
All lending institutions expect to make money off of their risk in forwarding money to home buyers. In order to ensure profit, they must also ensure that borrowers are unable to pay money back before a certain amount of interest has been paid. One way to do this is through pre-payment penalties. Signing up for a fixed rate mortgage means that a buyer also states that they will not pay the loan off under a certain amount of time. This allows the lender to continue to collect guaranteed interest. This applies even if the house is sold by the buyer at a profit or not; the mortgager will still apply penalties to the payoff.
Reducing mortgage payments
Most homeowners will eventually look at their mortgage statements and shake their heads over the amount they have paid, with very little of it going towards the principle. There are ways to greatly reduce the amount of interest that you pay on the loan, and therefore reduce the price of the house in general.
Making a large down payment. Making a large down payment will greatly reduce the amount of money that you need to borrow, and therefore the amount you pay in interest over time. The lending institutions make their most money in the first few years of a mortgage, as this is the time when the principle is largest. A large down payment will mean a lot less money paid during this time.
Lowering amortization periods. Decreasing the amount of time in an amortization period means a lot less money paid to the bank. This can be achieved by taking advantage of the no penalty prepayment window offered at specific intervals, usually at the time of refinancing the mortgage.
Taking advantage of payment options. Accelerated prepayment options allow the home buyer to greatly reduce the amount of interest they pay on mortgage principle. Usually, mortgage costs are assessed monthly. While weekly or bi-weekly payments will still total to the amount of the mortgage monthly, these more frequent payments will mean substantially more contributions to the principle instead of the interest. Buyers who take advantage of this option will often shave years off of their amortization period. For example, bi-weekly payments will reduce a 25 year term to 20 years when paid every two weeks for the entire term.
Mortgages are a necessity for most of today’s home buyers. Unfortunately, the use of a mortgage will often mean that home owners pay almost double (or even more) of the price that they bought their homes for. All of this extra money goes straight to the bank or to other lending institutions. Shopping around for the mortgage that best suits you and which will end up costing less in the long run is in the best interests of every potential home owner.