WHAT IS A MORTGAGE?
A mortgage requires you to pledge your home as
the lender's security for repayment of your loan. The lender agrees to hold the title or
deed to your property (or in some states, to hold a lien on your title or deed) until you
have paid back your loan plus interest.
Amount and Term
The mortgage amount is the amount of money you
borrow from a lender to pay for your house. The term is the number of years over which you
can pay back the amount you borrow.
The length of your mortgage repayment period will
directly affect your monthly mortgage payments. For the same mortgage principal
amount, you will find that the shorter your repayment period is, the higher your monthly
payments will be, but the total interest you pay over the life of the loan will be less.
On the other hand, the longer your repayment period is, the lower your monthly
payments will be, but the total interest you pay over the life of the loan will be more.
The most popular mortgage term is 30 years. By
extending payment over 30 years, you keep your monthly housing costs low. If you can
afford higher monthly payments, you can select a mortgage term that is shorter: there are
20-year, 15-year, and even 10-year fixed-rate mortgages available from most mortgage
Over time, you will repay your mortgage through
regular monthly payments of principal and interest. During the first few years, most of
your payments will be applied toward the interest you owe. During the final years of your
loan, your payment amounts will be applied primarily to the remaining principal. This type
of repayment method is called amortization.
Fixed Interest Rate
You can choose a mortgage with an interest rate that
is fixed for the entire term of the loan. A fixed-rate loan gives you the security of
knowing that your interest rate will never change during the entire term of the loan.
Adjustable Interest Rate
An adjustable-rate mortgage (called an ARM) has an
interest rate that will vary during the life of the loan, with the possibility of both
increases and decreases to the interest rate and consequently to your mortgage payments.
The down payment is the part of the purchase price
that the buyer pays in cash and does not finance with a mortgage. Your down payment will
reduce the amount youll need to borrow. So, the more cash you put down, the smaller
the size of your loan, and the smaller the amount of your mortgage payments.
Lenders often view mortgages with larger down
payments as more secure because you have more of your own money invested in the property.
However, you may have as little as 3 percent to 5 percent of the purchase price for
a down payment. Lower down payments help many people afford homes of their own
The closing (or, in some parts of the country,
settlement) is the final step, during which ownership of the home is
transferred to you. The purpose of the closing is to make sure the property
is ready and able to be transferred to you from the seller. Items to
be paid at closing vary from state to state and may include transfer taxes
and recordation taxes. Other closing costs are title insurance, the
site survey fee, attorney fees, loan discount points, and document
preparation fees. Usually, closing costs are expressed as a percentage
of the sales price or loan amount. Typically, costs range from 3 percent to
6 percent of the sales price of your home. Sometimes, you can
negotiate to have the seller of a property pay some of your closing costs.
In the special vocabulary of mortgage lending,
points are often used to describe a type of fee that lenders charge. (The full
term to describe this fee is discount points.) Simply put, a point is a unit
of measure that means 1 percent of the loan amount. So, if you take out a $100,000 loan,
one point equals $1,000. If you take out a $50,000 loan, one point equals $500.
Discount points represent additional money you can pay to the lender at closing.
In return, the lender will provide you with a lower interest rate on your loan.
Usually, for each point you pay for a 30-year loan, your interest rate is reduced
by about 1/8th (or .125) of a percentage point. So, if the current interest rate on
a 30-year mortgage is 8.5 percent, paying 1 point means you could get that mortgage for an
interest rate of 8.375 percent.
For example, you are shopping for a 30-year mortgage
loan. A lender quotes you an interest rate for a 30-year, $50,000 mortgage at 8.5 percent
with no discount points. If you like that rate, you can choose not to pay any
discount points at closing and pay 8.5 percent interest. If you want to pay less
interest, ask the lender to quote you interest rates with your paying 1, 2, or 3 discount
points. Usually, the longer you plan to stay in your home, the more sense it makes
to pay discount points.
Conforming and Nonconforming Loans
The term conforming, as opposed to
nonconforming, is sometimes used to explain loans that offer terms and
conditions that follow the guidelines set forth by Fannie Mae and Freddie Mac.
Fannie Mae and Freddie Mac are two private, secondary mortgage market companies that buy
mortgage loans from lenders, thereby ensuring that mortgage funds are available at all
times in all locations around the country.
The most important difference between a loan that
conforms to Fannie Mae/Freddie Mac guidelines and one that doesn't is its loan limit.
Fannie Mae and Freddie Mac will purchase loans only up to a certain loan limit
So, if your loan amount will be for more than the
conforming loan limit of $240,000, you may be asked to pay a higher interest rate on your
mortgage. Your mortgage loan may also follow slightly different underwriting
requirements, particularly in regard to your required down payment amount. Check
with your lender about this if you are taking out a large loan amount. Nonconforming
loans are sometimes called jumbo loans.