Mortgage Loans

A mortgage loan is a secured loan that uses real property as collateral. Mortgages consist of a few key components:

Property - A lot of land including any developed structures on the land that serves as collateral for the loan. The value of the property directly effects the term of the loan and the equity that a borrower can draw down.
Mortgage - Although often used interchangeably with the term “mortgage loan,” the mortgage is actually the contract between you and lender that lays out the terms and restrictions of the loan.
Principal - This is the outstanding amount left on the loan which must be paid according to the repayment terms and/or before the end of the loan term.
Interest - The finance charge levied by the lender (typically on an annual basis) for use of the lender’s money.
Foreclosure - Also called repossession, as with all secured loans, if the borrower defaults, the lender will then take possession of the collateral (in this case, the property or home).

As with virtually every type of loan, mortgage loan interest rates heavily depend upon the borrower’s credit history and income level. Other factors include the federal interest rate, real estate market conditions, the size of the principal vs. the value of the home (debt to value ratio) and promotions from the bank or credit union.

Types of Mortgage Loans

The two most common types of mortgage loans are fixed rate mortgages (FRM) and adjustable rate mortgages(ARM). With a fixed rate mortgage, the interest rate on the mortgage loan stays constant throughout the entirety of the loan, unless it is refinanced. Most fixed rate mortgages have 30 year terms. Adjustable rate mortgages, on the other hand, will typically be fixed for a period of time (i.e. 1 year, 3 years or 5 years). After this period expires, the interest rate will be adjusted according to the federal prime lending rate. Initially, adjustable rate mortgages often have interest rates that are 0.5 percent to 2.0 percent lower than fixed rate mortgages. However, depending on the prime rate, adjustable rate mortgages can quickly become more expensive than fixed rate mortgages.

A partial amortization mortgage loan, or balloon loan, is another type of mortgage loan. Balloon loans are typical of commercial mortgage loans or business loans. With a partial amortization loan, the monthly payments are amortized over a certain term (i.e. 15 years or 30 years), similar to a conventional fixed rate mortgage. However, the full amount of the loan becomes due before that period is reached. For example, if your loan was amortized for 10 years, you might make monthly mortgage payments for three years before paying off the balance at the end of the loan term.

Down payments and Home Equity

Most loans will require a down payment at the time of the loan. This is often referred to as a percentage of the value of the home. The difference between the loan and the value of the property being used as collateral is known as the loan-to-value ratio. So, if you were to put a $20,000 down payment on home priced at $100,000, your mortgage loan would be $80,000 and your debt-to-value ratio would be 80:20 or 80 percent.

As you begin paying down your mortgage loan, this ratio becomes known as equity. The debt-to-value ratio can be affected in two ways: by paying down your debt (i.e. by making payments as scheduled or making extra payments towards the principal) or by increasing the value of your home (i.e. through home improvements or market movements). When you build equity in your home, you can later withdraw it as cash through a remortgage, home equity loan or second mortgage.

The opposite of equity can also occur. When you owe more on a property than it is worth, this is known as being “underwater” or “upside down” on your mortgage loan. This can occur if your monthly mortgage payments are not enough to cover the interest and pay down the principal, or if the value of your home decreases.

Conclusion

There is much to consider when taking out a home mortgage loan. Each situation, borrower, lender and property is unique, so it pays to consider the circumstances on a case-by-case basis. However, by understanding the basic protocol of home mortgage loans and how the business and market works, you can ensure that you’re getting the most for your money.