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.
Mortgage Glossary3
