Mortgage Basics
Source: Freddie Mac's Online Guide to the Homebuying Process
What is a Mortgage?
A mortgage represents a loan or lien on a property/house that has to be paid
over a specified period of time. Think of it as your personal guarantee that
you'll repay the money you've borrowed to buy your home. Mortgages come in many
different shapes and sizes, each with its own advantages and disadvantages.
Make sure you select the mortgage that is right for you, your future plans,
and your financial picture.
What is an amortization schedule?
The month-by-month allocation of your monthly payment to the loan's interest
and principal is called an amortization schedule. With most loans you pay off
the interest on the loan before you pay off the principal (or the actual amount
you borrowed). Your lender will provide an amortization schedule to show you
how the percentage of your principal paid off increases with every payment,
while the percentage of interest decreases.
See an example of an amortization schedule
[PDF 10K].
Choosing the right mortgage.
Once you decide on the mortgage you want, do your homework. Different lenders
offer different rates, points, and fees. Ask around and compare.
Understanding the benefits of different mortgage offerings can be a complex
process. How do you figure it all out?
- Evaluate the pros and cons of a fixed-rate mortgage.
- Know all the parts of an adjustable-rate mortgage.
- Learn about balloon/reset mortgages.
Fixed-Rate Mortgages
Fixed-rate mortgages are the most common mortgage for many homebuyers because
the monthly payments are stable. The interest rate you lock-in will be the same
interest rate you pay for the life of the loan - whether it's a 15-year or 30-year
mortgage.
What are the benefits of a fixed-rate mortgage?
- Inflation protection.
If interest rates increase, your mortgage and your mortgage payment won't
be significantly affected. Even if your taxes or insurance costs go up over
time, your basic loan payment (principal and interest) will stay the same.
This is especially helpful if you plan to own your home for five or more years.
- Long-term planning.
You know what your
monthly housing expense will be for the entire term of your mortgage. This can
help you plan for other expenses and set long-term financial goals for yourself
and your family.
- Low risk.
You always know what your payment
will be, regardless of what current interest rates are. This is why fixed-rate
mortgages are so popular with first-time buyers.
There are additional considerations to be aware of with fixed-rate mortgages:
- Your mortgage interest rate won't go down, even if interest rates drop,
unless you refinance your mortgage.
- Because the interest rate is generally
higher than other types of mortgage loans, you may not be able to qualify
for as large a loan with a fixed-rate mortgage.
- Your total monthly payment
can occasionally increase based on changes to your taxes and insurance. In
many cases you pay these costs through an escrow account that your lender
keeps for you.
15-Year or 30-Year?
When you're looking for a mortgage, you need to decide which loan term you
want and choose the type of interest rate.
The loan term is the length of time you have to pay back the loan. The longer
the term, the lower the monthly mortgage payment. The shorter the term, the
higher the monthly mortgage payment.
Most home mortgage lenders offer two basic terms: 15 and 30 years, and many
also offer 20-year fixed rate mortgages.
- 15-Year Term
This term has higher monthly payments because the loan is shorter. The interest
rate is usually lower and you can build equity faster.
- 20-Year Term
This fixed-rate mortgage builds equity more quickly than with a traditional
30-year mortgage as well as saves you interest over the life of your loan.
- 30-Year Term
Interest rates may be somewhat higher for this term and you pay more interest
over time.
What type of loan term should you choose?
If you can make higher payments and want to build equity quickly, a 15-year
term may work for you.
If you want to qualify for a larger loan amount, a 30-year term may be a good
choice - especially if you don't plan to move and the interest rates are reasonable
when you sign the loan. This is generally the easiest loan term to qualify for.
You can always make larger monthly payments and ask your lender to re-amortize
your loan to pay your loan off faster.
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