The home mortgage industry is a multibillion-dollar industry with more being added on a daily basis. The basic reason being- everyone needs a home, and thanks to the “money does not grow on trees” nature of the green buck, real estate is something that cannot be easily afforded by a majority of society.
Mortgages, like bank houses, come in different shapes, sizes and prices, and in order to navigate through this vast jungle of policies, interests and payments, it would be quite useful to start from scratch in the knowledge of the same.
Picking up an earlier thread, the amount required to label a person as a homeowner is quite high, but this amount can be acquired in the form of a loan from many a financial institution. This loan and the contract allowing this loan are referred to as a mortgage. Since the mortgage institutions are not primarily into the charity business, they tend to charge the borrower for the liberty they have provided in using their money. This charge is a percentage of the sale amount and is called the interest amount. There are two types of interest – the fixed rate interest and the adjustable rate interest (ARM). The former provides fixed rate and monthly payments that extend over a 15 year or 20 year period. The latter i.e. ARM, have a fixed rate period initially, and a longer period wherein the interest rate fluctuates as per market interest rates.
Moving on to another significant factor in the mortgage game is the down payment. Every lending agency expects the borrower to provide a certain percentage of the sale price as a down payment. This could be five, ten or twenty percent of the sale price. The percentage is solely decided by the method of operation of the mortgage lender. Certain agencies have been known to provide up to 97 percent of the loan amount, the reason being that they can pass on the risk behind such loans onto somebody else. The lenders sell their loans to the Federal National mortgage Association (Fannie Mae) which then combines them into securities, and at the end of the line, it is sold of to investors.
Though the low mortgage down payments may sound like a good idea, it has a two-fold effect. Primarily, the borrower has to pick up Private Mortgage insurance (PMI) to protect the lender. This can be an additional one and a half percent of the loan amount. Secondly, it lowers the equity value of the house to a large degree.
Equity is defined as the difference between the current value of your home and the amount left on your mortgage.
For example,
Assume that a house costs $300000, the down payment (at 20 percent) is $60000 and the remaining $240000 is borrowed. In the beginning, the equity value equals the down payment.
Cost of house ($300000) – Amount left on mortgage ($240000) = Equity ($60000)
Consider a period of six years, and as result of regular payments, the borrower has paid off nearly $63000 of the mortgage, and has another $237000 left. In the same period, the value of the house has risen by another $50000. The equity value now becomes
Value of house (350000) – Amount left on mortgage (237000) = Equity ($113000).
The advantage is that, the borrower can now convert that equity value into cash, by taking up a second loan to pay for any other needs.
In both cases i.e. the mortgage and a loan taken based on the equity value, the house and the land it stands own, will be used as collateral. Any default in payment for a long period, will cause the lender to foreclose on the house and sell it off.
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