Are you thinking about buying a house? Or maybe youve heard a lot of talk about the low interest rates and think this is the perfect time to buy a home? Well, your right there couldnt be a better time to buy a house. But the home buying process can be little daunting, realtors and mortgage brokers throw around a lot of terms that can be more than a little confusing. Lets eliminate some of the confusion by explaining a few of the terms related to getting a mortgage and answer some of the common questions.
Whats a mortgage?A mortgage is a contract between a home owner and a bank or financial institution for the repayment of a debt. That debt is incurred upon the purchase of real estate. As part of that mortgage, the financial institution holds a lien on the property. A lien is a legal claim to the property if the mortgage is not repaid according to the agreed upon terms.
Whats included in the mortgage agreement?The mortgage agreement contains all the information necessary for the purchase of the home and the repayment. A mortgage clearly sets out the rules for the repayment of the loan, including:
- The size of the loan: how much money the home owner is borrowing to purchase the real estate;
- The interest: how much money is the lender charging the customer in the repayment of the loan the amount paid for the use of the money to purchase the home or property. Interest is expressed as an annual percentage rate.
- The term: how many months (or years) before the mortgage is completely paid in full. Its typical for the loan term to be listed in month in total number of months, for instance, if you have a 30 year loan, the term will be 360 months.
So, it sounds like a mortgage is made up of the amount of money borrowed (the purchase price of the property) and interest on the loan, right? Well, actually a mortgage has a few more components that many people overlook.
In some ways, financial institutions have some additions to the mortgage that benefit the borrower. For many home owners, paying the monthly mortgage eats up a huge part of the monthly budget. Imagine how easy it would be to miss a couple payments for insurance on the home, or be late paying the taxes. These expenses are all part of the monthly mortgage. The components of the monthly mortgage payment are:
- Principal: this is that actual purchase price that you are repaying;
- Interest: As we said, the interest is calculated at a yearly average;
- Real Estate Taxes: theres no way to avoid paying taxes on your home. Of course, your county or city assesses taxes on your property at a yearly rate. But rather than forcing you to come up with the tax amount in one lump payment, the financial institution averages out that amount over the year into monthly payments. The financial institution collects the amount for taxes and its put in an escrow account (a holding account that doesnt earn or charge interest). They pay the taxes either every six months or yearly.
- Property Insurance: the mortgage company also collects money to pay the insurance on your home. You, of course, choose your preferred insurance company. The insurance covers your house against, fire, accidents, theft, etc. Payment of your insurance is much the same as payment of the taxes.
- Private Mortgage Insurance: The lender takes out insurance too, but this insurance covers your repayment of the loan. If you did not make a down payment on the home of 20%, the lender will often choose to take out Private Mortgage Insurance (PMI). This insurance protects them in the event you were to default on the loan, but of course, you pay the insurance as part of your monthly payment. When the repayment amount drops below 80% of the value of the home, the PMI will be discontinued.