How do Mortgages Work?
Now that the mortgage industry has become tightly regulated since the housing crisis, few mortgages (VA loans are an exception) are available without a down payment on your part. FHA loans will allow you to put down three and a half percent of the appraised value on a home and the rest is covered by a mortgage.
Once you qualify and the house has been appraised at not less than the price the seller is asking, a lender will advance you the money to pay the seller, in exchange for your signature on a legal document that allows the seller to retain a financial interest in the property until you pay in full.
Components of a mortgage payment
- Principal: The difference between the price you are paying for the house and your down payment.
- Interest: The cost of the money you are borrowing usually displayed as a percentage rate.
- Taxes: The municipality and/or county in which you live charges a tax for services they provide in your community. Your mortgage servicer collects this and places it in an escrow account for payment to the correct governmental authorities.
- Insurance: You pay for hazard insurance to protect against losses due to fire, theft, vandalism and other damaging occurrences. Your home is likely the main collateral for the loan and insurance protects the value of that collateral.
With a fixed mortgage, your payment may actually vary slightly from year to year if your taxes and insurance costs change. The principal and interest components total the same but the longer you hold themortgage, more money goes to paying down the principal and less to paying interest.
Fifteen year loans work well for people who expect their incomes to continue to rise sharply and who have spare cash, allowing them to put more money into a mortgage payment. Let's help you with that decision:
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Fixed rate mortgages
A fixed rate mortgage offers an interest rate that cannot change over the life of the loan. The traditional fixed rate mortgage ran for 30 years and was an attractive option for buyers who are on tight budgets and wanted to spread payments over as long a period as possible. The downside here is that you pay the highest total interest over time.
Some lenders offer a 20 year mortgage that allows borrowers to build equity faster and get the loan paid off sooner. They usually carry lower interest rates than their 30 year counterparts and are handy if you are not on a restrained budget.
Fifteen year loans are less risk to lenders as they recover their money sooner. Consequently, interest rates on these loans are lower but monthly payments are higher as your payment period is much shorter than a 30 year loan. They work well for people who expect their incomes to rise sharply, allowing them to put more money into a house payment.
Adjustable rate mortgages
Adjustable rate mortgages are attractive products because they offer lower interest rates than their fixed counterparts. ARMs are now tightly regulated and offer myriad protections and warnings to the borrower prior to closing. Some adjustable rate mortgages can run as long as seven years before the first adjustment kicks in (a 7/1 ARM) and are useful for people who want a low rate and do not expect to live in the home for a long period of time. Adjustable rate mortgages must specify how long the loan will run before the first adjustment, how much each adjustment can be and how many adjustments can occur. Lenders are required by law to be very specific about the terms of adjustable rate mortgages and to provide borrowers with detailed, written information.
A special class of mortgage called a reverse mortgage allows people aged sixty two and over to access the equity in their homes though a loan against the equity. They do not have to pay the loan back as long as they or a named spouse live in the home and do not sell it. Reverse mortgages are handy for senior citizens who are on fixed income and are short of cash on a monthly basis.