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How Mortgages Work - The Basics of a Mortgage
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The main parts
of a mortgage to learn about are the parts of a payment, PMI
, escrows, and what amortization is
A mortgage is a long term loan that you obtain
through a bank, financial institution, or sometimes through the seller
of the property on a Land Contract. In all cases, the home and/or property
serve as the collateral for the loan. This means that you put up the house
in return for a mortgage. If you do not make the payments, the lender
will take the house back.
As some in the mortgage industry call it, "no pay, no stay!"
Most likely, a home mortgage is the largest debt you will ever incur.
And, you will typically pay off that debt in 15 or 30 years. When you
are first learning about a mortgage, it can seem very overwhelming since
you are signing for an obligation for a very long time to come. Hopefully
after reading through these articles you will become more comfortable.
The main goal in getting a mortgage should always be first finding someone
you can trust, can work with, will treat you fairly and you are not afraid
to ask questions of.
So, what's in a payment?
You will hear the terms PITI when you are
involved in getting your mortgage. This stands for:
- Principal
- Interest
- Real Estate Taxes
- Property Insurance
and, often, PMI, also known as private mortgage insurance
Principal
- this is how much of the balance of your mortgage loan is paid during this
month's payment
Interest - this is how much of this month's payment goes to paying
the interest that has accrued on your loan this month
Real Estate Taxes - When there is an escrow account, the bank collects
an amount each month and puts it into an account to pay your real estate
taxes when they are due. This amount will change (usually higher!) as your
taxes change
Insurance - like the taxes, the bank collects enough each month to
pay the insurance bill when it comes due. You get to choose your own insurance
agent and they forward the bill to your bank so that they know how much
to charge you.
What's
PMI?
PMI protects the lender should the borrower default on the loan. The mortgage
company charges insurance if the down payment is less than 20% of the sale
price or appraised value of the home. The smaller the downpayment, the greater
the rate of PMI.
You have likely heard of "Federally Insured Loans." With a mortgage,
the government will only insure 80% of the value of a house and when you
have less than a 20% down payment, you have to pay another company to insure
the difference between what the government covers and the amount of your
loan. Once you have paid down your mortgage, PMI is no longer needed since
you now have 20% equity in your home.
While PMI is a great way to get into a home, but when you are in a loan
with PMI, you should keep your eyes out as to how quickly you can remove
that charge from your payment. Read more about PMI here.
Escrows
Escrows are payments you make each month to the bank or lender that are
put into an account that is yours (not the banks!) that is used to pay your
Real Estate Taxes and your Homeowner's Insurance when they become due.
When you have less than 20% as a down payment on your house or less than
20% equity in your home, an escrow account is usually required.
Basically, the bank requires this account to be in their possession because
they take the position that borrowers who haven't been able to save 20%
of the value of the house may have trouble saving enough to pay the taxes
or insurance when they become due.
On a more legal note, the bank wants to make sure that taxes and insurance
are paid up so that they do not lose their investment that they have made
in your house.
One advantage to an escrow account is that if there is not enough in the
account to pay the bill, the bank will go ahead and pay what is due. They
then collect from you any additional amount that had to be paid. This amount
is usually split up over 12 months without interest.
Amortization
You will hear this word used when you are getting a mortgage. This is the
process of paying off the principal on a loan is based on a repayment plan
with equal payments over the life of the loan called amortization.
In order to have affordable monthly payments on this large debt, a homeowner
will pay a lot of money toward interest during the length of the loan. The
first few years, more of your payment will go towards interest than to the
principal and in the later years more of the payment will go towards the
principal.
Amortization is really just a way of averaging all the interest due on the
loan.
Here is an example to put this into plain english for you. Let's say that
you have a mortgage of 144,000 for 30 years. If there were no interest at
all, you would have 360 payments of $400 each month. (400 x 360 = $144,000)
Now, let's say that instead of amortization, a mortgage was set up so that
you made that $400 plus any interest due on the balance of the loan each
month, the early payments would be so large you could not afford much of
a house!
Look at this! During the first month, Interest at 6% on that $144,000 would
come to an extra $720 and the first payment would amount to $1120. As the
balance went down, so would your payments.
However, with amortization and averaging the interest out, that same payment
would be only $863.35 each and every month and how that payment is divided
up towards principle and interest is the only thing that changes.
Summary
As you first start to learn about a mortgage, the facts can be scary and
seem a little overwhelming. Get yourself a good mortgage banker and stick
with them through the years and it may pay you back tenfold in your savings.
Hopefully after reading this website, that mortgage professional will be
me! Click here to get more info
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