Mortgage basics

Mortgage basics

Purchasing a home involves getting a mortgage. A mortgage is a written pledge of property used as security for the repayment of a loan. The property you purchase is the collateral for the mortgage. If you fail to make payments on the loan, the lender can repossess your home. As a result, the lender has some legal rights on your property as you pay off your mortgage. Unlike a standard loan, the mortgage is used to enforce the lenders rights to the property if the borrower does not repay the home loan. If the borrower does not keep up with his/her monthly mortgage payments, the borrower can obtain the home through what is called foreclosure. Foreclosure is the forced sale of a home or property that is pledged as security against a mortgage. The property is sold so the lender can recoup its losses on the loan.

Home mortgage loans are offered commonly in 15 or 30-year fix rate periods. The term refers to the amount of time the lender allows for the mortgage loan to be repaid. Therefore, a 30 year loan spreads loan payments across a 30 year time span. The fixed-rate refers to the interest rate. The interest rate is a percentage of the loan the borrower must pay to the lender, in addition to the monthly payment, for lending them the money. In a fixed-rate mortgage, the interest rate does not change. It remains constant throughout the term of the loan.

The actual amount of the mortgage is called the principal. When the borrower first starts paying off the loan, interest is paid off first, then the principal. For example, if the interest rate on your mortgage is 6%, and the loan amount is $100,000, you will pay in addition to the principal, $6,000 to the lender. The lender includes interest into the monthly payments, however, the principal and interest isn’t split 50/50 for each monthly payment. Interest is paid first; anything remaining goes toward paying off the principal. To figure out the percentage of your monthly that will go to interest payments, the lender takes your mortgage interest rate (6%) and breaks it down into a decimal (.06). Then the lender divides that decimal by 12 (.06/12 = .005). Then the lender takes the new number and multiplies it by the principal of the mortgage (.005 x 100,000 = 500). The end result is the monthly interest rate payment. If your overall mortgage payment is $700, $500 goes towards paying off the interest, and $200 goes toward paying off the principal.

However, as you pay down the principal, the actual dollar amount paid to interest vs. what is paid to principal changes each month. Your overall monthly payment doesn’t change, but the ratio between interest-to-principal pay off does. For example, after you pay your first month’s mortgage payment, the next month’s payment is based on the principal being $99,800 ($200 less than the first month). So, when the formula is applied to the next month’s payment, the interest and principal payments are adjusted based on what is still owed ($99,800), the interest rate, and the established monthly mortgage payments.

Fixed-rate mortgages aren’t the only home loans offered. Some loans have fluctuating interest rates while others have shorter terms. Most new home buyers stick with a fixed rate 15 or 30-year mortgage because there are no surprises; the interest rate and monthly payments remain the same.

If you’re about to buy a home, be aware of how your standard mortgage operates, and establish early on if you have the finances to afford a mortgage. If you get involved in a mortgage and later discover you can’t afford it, it could cost you your new home.

Copyright 2006 Brad Stroh