What is a 'Mortgage'
A Mortgage is a debt Instrument, secured by the Collateral of specified Real estate Property, that the Borrower is obliged to pay back with a predetermined set of payments. Mortgages are used by Individuals and Businesses to make large real estate purchases without paying the entire value of the purchase up front. Over a period of many years, the Borrower Repays the loan, plus Interest, until he/she eventually owns the property free and clear. Mortgages are also known as "liens against property" or "claims on property." If the Borrower stops paying the Mortgage, the bank can foreclose.
BREAKING DOWN 'Mortgage'
In a Residential Mortgage, a Home Buyer pledges his or her House to the Bank. The Bank has a Claim on the House should the Home Buyer Default on Paying the Mortgage. In the case of a Foreclosure, the bank may evict the home's Tenants and sell the house, using the Income from the sale to clear the Mortgage debt.
Mortgages come in many forms. With a fixed-rate Mortgage, the Borrower pays the same Interest rate for the life of the loan. Her monthly principal and interest payment never change from the first Mortgage payment to the last. Most fixed-rate Mortgages have a 15- or 30-year term. If market interest rates rise, the borrower’s payment does not change. If market Interest rates drop significantly, the borrower may be able to secure that lower rate by Refinancing the Mortgage. A fixed-rate Mortgage is also called a “Traditional" Mortgage.
With an Adjustable-Rate Mortgage (ARM), the Interest rate is fixed for an Initial term, but then it fluctuates with market Interest Rates. The Initial Interest rate is often a below-market rate, which can make a Mortgage seem more Affordable than it really is. If Interest rates Increase later, the Borrower may not be able to Afford the Higher Monthly Payments. Interest rates could also Decrease, making an ARM less Expensive. In either case, the monthly payments are Unpredictable after the initial term.
Other less common types of Mortgages, such as interest-only Mortgages and payment-option ARMs, are best used by Sophisticated Borrowers. Many homeowners got into financial Trouble with these types of Mortgages during the housing Bubble years.
When Shopping for a Mortgage, it is Beneficial to use a Mortgage Calculator, as these tools can give you an idea of the Interest Rates for the Mortgage you're considering. Mortgage Calculators can also help you Calculate the Total cost of Interest over the life of the Mortgage.
[ Getting a Mortgage is a How nearly everyone Finances their newly Bought home but accruing certain amounts of long-term Debt doesn't mean you have to stop Investing. Learn how to Invest for the future, plan to create a Conservative Portfolio based on Individual Debt load and many other Financial skills in Investopedia Academy's Personal Finance for Beginners course. ]
HOW IT WORKS (EXAMPLE):
Mortgage loans are usually Entered into by home Buyers without enough cash on hand to purchase the home. They are also used to Borrow cash from a Bank for other projects using their house as Collateral.
There are several Types of Mortgage loans and Buyers should assess what is Best for their own Situation before entering into one. Types of loans are characterized by their term dates (usually from 5 to 30 years, some Institutions now offer loans up to 50 year terms), interest rates (these may be fixed or variable), and the amount of payments per period.
[If you're ready to buy a home, use our Mortgage Calculator to see what your monthly principal and interest payment will be. You can also learn how to calculate your monthly payment in Excel.]
Mortgages are like any other Financial Product in that their Supply and Demand will change Dependent on the market. For that Reason, sometimes banks can offer very low interest rates and sometimes they can only offer high rates. If a borrower agreed upon a high interest rate and finds after a few years that rates have dropped, he can sign a new agreement at the new lower interest rate -- after jumping though some hoops, of course. This is called "Refinancing."
WHY IT MATTERS:
Mortgages make larger purchases possible for individuals lacking enough cash to purchase an asset, like a house, up front. Lenders take a risk making these loans as there is no guarantee the borrower will be able to pay in the future. Borrowers take risk in accepting these loans, as a failure to pay will result in a total loss of the asset.
Home ownership has become a cornerstone of the American Dream. For most people, their home is their most valuable Asset. Mortgages make home buying possible for many Americans. Mortgages are not always easy to secure, however, as rates and terms are often dependent on an individual's credit score and job status. Failure to repay allows a bank to legally foreclose and auction off the property to cover its losses.
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