Mortgage Basics
Written by Dongmiao Cui   


What Is a Mortgage?

A mortgage loan is a loan secured by real properties through the use of a mortgage note.  A mortgage note, in the United States, is a written promise to repay a specified amount of money as well as interest, at a specified rate and over a specified length of time. Should a borrower default and fail to fulfill that promise, the property is seized as collateral.

The mortgage is originated by a lender, such as banks, credit unions or mortgage brokers. They sell the loans to consumers and profit from the interest rates and fees they charge the consumers. Most mortgage lenders do not retain the loan asset. They sell the mortgage into the secondary mortgage market.

The interest rates that they charge consumers are determined by their profit margins and the price at which they sell the mortgage to the secondary mortgage market.

In the secondary mortgage market, similar mortgages are pooled together to form mortgage-backed securities through a process known as securitization. Investors buy and trade these mortgage-backed securities. Ultimately it is the investors that determine mortgage rates offered to consumers.


5 Basic Elements in Your Mortgage Finances

If you are interested in obtaining a mortgage loan to finance your house, it is helpful to understand the important elements and variables that make up your contract. Below are examples of the key variables that will be frequently discussed when you start your mortgage shopping.
  1. Property
The Real Property in the definition of a mortgage loan refers to the physical residence being financed or used as collateral.
  1. Principal
Principal is the original size of the loan, and may or may not include certain other costs.
  1. Interest
Interest conventionally refers to the financial charge for the use of the lender’s money. Ultimately it is the investors in the secondary mortgage market that determine the interest rates offered to consumers.

The interest rate on a fixed-rated mortgage is highly correlated with the yield of U.S. Treasury bonds. In practice, the yield of the 10-year bond is used as a benchmark for the interest rate of 30-year fixed-rate mortgages.

The interest rate on adjustable rate mortgages changes monthly, semiannually or annually. It is composed of a mortgage index interest rate (the benchmark interest rate) and a fixed margin. The mortgage indexes are constructed based on the interest rates on financial securities, or bank loans or deposits. Common mortgage indexes include the one-year constant maturity treasury value and the LIBORs, etc. The margin serves as the profit that your lender earns over the loan. It remains fixed over the lifetime of the loan. The higher the margin, the more costly your loan is. For example, a mortgage interest rate may be LIBOR plus 2%. LIBORW is the index and 2% is the margin.
  1. Term of Loan
This is the duration of the loan, up to 30 years, with 15 and 30 being most common. Depending on the loan amount, you can pick the term that best fits your monthly payments.

A short-term mortgage is usually for 2 years or loss whereas a long-term loan is for three years or more. A short term mortgage charges a higher interest rate but can be paid off faster. On the other hand, a long-term mortgage offers a lower rate and more affordable periodic repayments. Affordability is the major concern when choosing between short term and long-term mortgages. 

However among long-term mortgages, there are two popular choices: a 15-year loan, and a 30-year loan. A 30-year loan offers a lower monthly payment but a higher interest rate than the 15-year loan. This means that you will have a smaller monthly obligation but you will pay more overall. In general, the monthly payments for the 15-year mortgage may come off a heavy burden for most first-time homebuyers. But it could be a good choice for buyers with adequate income who wish to be mortgage-free sooner.
  1. Prepayment
Prepayment refers to the early repayment of a loan by the borrower: paying off all or a portion of your loan before it is due. However prepayment does not simply mean adding money to your monthly installment. It is perceived by your lender as carrying additional risk and therefore may or may not be approved. This is because your lender may lose some interest of profit if the loan is shortened upon prepayment. To compensate for possible loss of interest, your lender may impose a prepayment penalty, which will also be clarified in the contract. You will still have the right to make prepayment if you wish to, though you will pay the cost of the prepayment penalty. 




Last Updated on Wednesday, 22 December 2010 05:09