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How Mortgage Lending Works



Mortgage Lending is a legal contract that pledges property to a creditor as collateral for a loan, and is typically arranged through a bank or other mortgage lenders. Because mortgages are such large loans, consumers pay them off over a long period of time, typically 15 to 30 years.

How the Mortgage Lending market works:

It is useful when shopping for a mortgage to have a basic understanding of how the mortgage market works.

  • Bankers and other mortgage lenders use short-term borrowings to make mortgage loans to home buyers. This is typically referred to as the primary market.

  • These loans are then grouped together into packages and put up for sale to outside investors, which are usually large institutions.

  • The proceeds from the sale are used to pay off the initial bank loan and replenish the lending capital.

  • There is also a secondary market where pools of residential loans are sold and resold after origination. This secondary market includes such participants as thrifts, commercial banks, life insurance companies, pension and mutual funds, and institutions such as the Federal National Mortgage Association (Fannie Mae), the Government National Mortgage Association (Ginnie Mae), and the Federal Home Loan Mortgage Corp. (Freddie Mac).

What's in a payment?

A monthly mortgage is known as PITI payment, made of up the following four costs:

  • Principal - The original amount of a debt on which interest is calculated.

  • Interest - Interest is a surcharge on the repayment of debt (borrowed money.)

  • Real Estate Taxes - Taxes levied by different government agencies to pay for public projects like school construction, fire department service, etc.

  • Property Insurance - Insurance coverage against theft and natural disasters such as fire, hurricane, flood, etc. Often, a separate levy for government-backed mortgage insurance premiums - also known as private mortgage insurance (PMI) - is also included.

The down payment is the lump sum paid upfront that reduces the amount of money that needs to be paid back later. If the down payment is less than 20 percent equity of your home (equity is the amount of your home's value already paid for), a PMI will be charged. The PMI can be eliminated once the principle balance reaches the loan-to-value (LTV) ratio, which is 80 percent of the sale price or appraised value of the property.

Mortgages Loans are typically paid off in incremental payments based on a repayment formula called amortization. This means that the interests owed on the mortgage is spread over many payments so that the overall loan is as affordable as possible. For the first few years, the portion of the mortgage payments that goes towards paying the interest is much higher than the portion that goes to the principal. During the final years of the loan, payments will be applied primarily to the remaining principal.

Example: A 30-year, $200,000 mortgage with a fixed interest rate of 6.5 percent, a homeowner will have to pay $255,088.98 in interest. Because the interest is so high, it is spread over the full 30-year term. This keeps the monthly payments at a manageable $1,264.14, most of which will go towards paying off the interest in the early years of the loan, with more and more of the payment going towards paying off the principle as time passes.

Despite the high mortgage lending interest rate, there are advantages in taking out a home mortgage, including the pleasure of living in your own home while building equity, as well as tax incentives, since mortgage interest is a deduction on your federal income tax.

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10721 Jackson Lane, Frisco TX 75035

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