Buying a home is one of the most expensive investments a person will make in their lifetime and for most people, it involves a significant financial commitment. Some home buyers are fortunate enough to be able to pay for the cost of their new home up front, but for many, the only option is to take out a loan in order to buy a house, which is also referred to as a home mortgage. A home mortgage is typically a long term, multi-year loan, and includes collateral and interest payments as well as other fees and taxes. Most major banks and financial institutions offer home mortgage loans to home buyers although the terms and rates can vary widely between institutions and across states.
When a person takes out a home mortgage, they are essentially entering into a contract with the lender whereby the lender agrees to give the borrower the money needed to purchase their home on a fixed term basis, and the borrower uses their new home as collateral for the loan. The concept of collateral is crucial to the way in which home mortgage loans work. Until the loan is fully paid off, the home owner does not have complete ownership of their home – in essence, the home is under a lien from the lending company. If the home owner defaults on the loan, the lending institution has the right to reclaim the collateral of the loan, namely the home, and sell it, along with any of its contents, in order to recoup their money. This process is called foreclosure and is the lender’s only recourse when a borrower is unable to make their mortgage payments.
Most lenders require borrowers to put down a percentage of the loan amount as a down payment, typically 20%, although some lenders do accept a lower down payment which can be as little as 5% of the loan amount. In fact, many lenders require a minimum down payment as a condition of the loan. Lenders calculate the interest rate of the mortgage based on the loan amount as well as the down payment amount. The higher the down payment, the lower the interest rate typically is.
There are two primary types of home mortgages offered by lenders, namely fixed rate mortgages and adjustable rate mortgages. In a fixed rate mortgage the interest rate is set when the loan is initially negotiated and remains fixed for the duration of the loan term – it cannot change regardless of market fluctuations. By contrast, an adjustable rate mortgage offers borrowers a relatively low interest rate for the initial term of the loan, (a period that is determined by the lender), but then varies based on market rates. This means that a borrower’s interest rate and loan payments will fluctuate from month to month. Most borrowers choose a fixed rate mortgage because of the stability in the loan interest rate. With an adjustable rate mortgage it can be difficult to predict the amount of the mortgage payment, and many borrowers find themselves in a situation where the market rate causes their interest rates and mortgage payments to balloon beyond their means.
A mortgage also includes other fees, in particular home owner’s insurance and property taxes. Home owners are required to purchase home owners insurance in order to protect the home – if the home is destroyed and cannot be replaced due to a lack of insurance, the lender essentially loses out on their investment. For this reason, lenders often open an Escrow account for borrowers with a portion of their monthly payment being put aside to pay for insurance as well as annual property taxes. Getting a good rate on a home mortgage can be a complex process. A good realtor can help guide borrowers to reliable lending institutions with competitive rates and can help make the process easier for first time home buyers.