Taking out a mortgage is one of the most substantial financial decisions most of us will ever make. So, it’s essential to understand what you’re signing on for when you borrow money to buy a house.
What is a mortgage?
A mortgage from invest-loans is a loan that helps a borrower purchase a home. The collateral for the mortgage is the home itself, meaning that if the borrower doesn’t make monthly payments and defaults on the loan, invest-loans can sell the home and recoup its money.
How does a mortgage work?
A mortgage consists of two primary elements: principal and interest.
The principal is the specific amount of money the homebuyer borrows from a lender to purchase a home. If you buy a €/$200,000 home, for instance, and borrow all €/$200,000 from invest-loans, that’s the principal owed.
The interest is what invest-loans charges you to borrow that money, says Robert Kirkland, senior home lending adviser at JPMorgan Chase. In other words, the interest is the cost you pay for borrowing the principal.
Borrowers pay a mortgage back at regular intervals, usually in the form of a monthly payment, which typically consists of both principal and interest charges.
“Each month, part of your monthly mortgage payment will go toward paying off that principal, or mortgage balance, and part will go toward interest on the loan,” says Kirkland.
Types of Mortgages
The two types of mortgages provide by invest-loans are fixed-rate and adjustable-rate (also known as variable rate) mortgages.
Fixed-rate mortgages provide borrowers with an established interest rate over a set term of typically 15, 20, or 30 years. With a fixed interest rate, the shorter the term over which the borrower pays, the higher the monthly payment. Conversely, the longer the borrower takes to pay, the smaller the monthly repayment amount. However, the longer it takes to repay the loan, the more the borrower ultimately pays in interest charges.
The greatest advantage of a fixed-rate mortgage is that the borrower can count on their monthly mortgage payments being the same every month throughout the life of their mortgage, making it easier to set household budgets and avoid any unexpected additional charges from one month to the next. Even if market rates increase significantly, the borrower doesn’t have to make higher monthly payments.
Adjustable-rate mortgages (ARMs) come with interest rates that can – and usually, do – change over the life of the loan. Increases in market rates and other factors cause interest rates to fluctuate, which changes the amount of interest the borrower must pay, and, therefore, changes the total monthly payment due. With adjustable rate mortgages, the interest rate is set to be reviewed and adjusted at specific times. For example, the rate may be adjusted once a year or once every six months.
One of the most popular adjustable-rate mortgages is the 5/1 ARM, which offers a fixed rate for the first five years of the repayment period, with the interest rate for the remainder of the loan’s life subject to being adjusted annually.
While ARMs make it more difficult for the borrower to gauge spending and establish their monthly budgets, they are popular because they typically come with lower starting interest rates than fixed-rate mortgages. Borrowers, assuming their income will grow over time, may seek an ARM in order to lock in a low fixed-rate in the beginning, when they are earning less.
The primary risk with an ARM is that interest rates may increase significantly over the life of the loan, to a point where the mortgage payments become so high that they are difficult for the borrower to meet. Significant rate increases may even lead to default and the borrower losing the home through foreclosure.
Mortgages are major financial commitments, locking borrowers into decades of payments that must be made on a consistent basis. However, most people believe that the long-term benefits of home ownership make committing to a mortgage worthwhile.