A mortgage is just a fancy name for a loan that is used to buy a house or other real estate property. A mortgage is backed up by the value of the property which was purchased with the mortgage proceeds. Although you have legal title to the property, the bank has what is called a lien on the property which means that if you default on your loan the bank has the right to take legal ownership of your property.
On of the best things you can do to protect yourself from getting taken advantage of when looking for a mortgage is to get a simple financial calculator and learn how to use it. A loan officer cannot deceive you with the numbers if you know how to calculate them yourself. I have found the HP 10BII financial calculator the easiest to understand and use. Learning to calculate what your payments will be under different interest rate scenarios is not difficult at all. Also, as you determine what you can afford to spend each month on a home you will be able to use your calculator to quickly determine what that monthly amount equates to in terms of the price of a home you can afford.
The elements of a mortgage:
- Present Value (PV) - is how much you owe at the present time, basically this is the principle balance of your loan that decreases as you make mortgage payments.
- Future Value (FV) - for purposes of calculating payments and interest rates is in nearly all cases assumed to be zero, meaning you will pay your mortgage off so that its value in the future will be zero.
- Number of payments (N) - most mortgages last 30 years and are paid on a monthly basis for a total of 360 payments.
- Payment (PMT) - is the amount you pay each period (month). As the number of payments decreases your payment will be higher.
- Interest Rate (I) - is the rate of interest you are charged for borrowing the money. This rate is usually expressed as an annual rate so that if you borrow $100,000 at 6% your first monthly payment will include interest charges of $500, which is the 6% annual rate divided by 12 to make it a monthly rate and then multiplied by the $100,000 balance.
How a mortgage works
In the first few years of your mortgage most of each payment will go toward paying the interest. Very little of your payment will actually be paying down the balance. But as the balance gradually gets smaller then the interest charges each month gradually get smaller also which leaves more of each payment available to pay down the balance of the loan. In the last years of your mortgage, most of your payment will be going to paying off the loan. Essentially, the balance starts out decreasing very slowly and ends decreasing very rapidly.
Variable vs. Fixed rate mortgages
There are many different types of mortgages. When buying a house, the most common type of mortgage for most people is a traditional thirty year fixed rate mortgage. Many bankers and mortgage people will try to get you in a variable rate mortgage because then you bare the risk if interest rates rise; and with rates at all time lows, that's really all they can do is rise.
The reward for baring the risk of a variable rate mortgage is that you receive a slightly lower interest rate to begin with. Depending on your circumstance and how long you plan to be in the home these types of mortgages my be to your advantage. But, if you don't feel comfortable understanding this type of loan, and your not sure how to figure out if it is to your benefit, then be very weary of a variable rate mortgage and just stay with a fixed rate mortgage.