Learn The Basics of a Mortgage

by : Peter Kenny

Learning more about the basics of mortgages can help consumers better understand the home loan process and possibly keep some from getting into trouble.

What exactly is a mortgage?

A mortgage is a loan contract or legal agreement between the lender and the buyer. The mortgage will contain important information about the loan such as the interest rate that is being charged, the amount of the loan, the payments, and other information, some of which is required by law to be in the contract.

What is a down payment?

The down payment is the lump sum of money that has to pay upfront that will reduce the amount of money you have to finance through the lender. Buyers are allowed to put down as much money as they wish. The more money that is put down the less the monthly payments will be.

A normal mortgage payment is made up of:

Principal - This is the total amount of money you are borrowing from the lender. This is the amount of money that you are financing through the lender.

Interest - This is the amount of money the lender charges for giving you the loan. It is a percentage of the total amount of money you are borrowing.

Taxes: In many states, the money that is needed to pay property taxes is put into an escrow account or is paid at the time of the closing. In other states, the tax money is put into a third- party account until it is time to pay the taxes. In other words, a portion of your property tax is added to your monthly mortgage payment and held in escrow until it is due.

Insurance - There are many kinds of insurance that can apply to a mortgage. You may have hazard insurance which is used to protect you against losses from fire, storms, theft, and the like. You may also have to buy flood insurance if the home is in flood risk zone. If you cannot put down at least twenty percent of the home's value, you will have to buy private mortgage insurance. This is also known as PMI.

All of the above is usually referred to as PITI.

For the most part, home mortgages are paid off in incremental payments. In the early years of the loan, most of the payment goes toward paying the interest. In the latter years, more goes toward paying down the principal. This is known as amortization.

Once the loan goes into effect, homeowners may wish to make additional payments on the loan. This will help to reduce the length of time, and the amount of interest, on the loan.

Sub-prime loans are those loans that are issued to people with less than perfect credit histories. These loans can have any number of terms and are usually adjustable rate mortgages.

Prime loans are issued to those with good credit and they are usually less expensive because they have lower interest rates. Prime loans can be either adjustable rate based, or they can be fixed-rate based.