Reproduced with permission from the Real Estate Center: http://recenter.tamu.edu
By Jack Harris, Mark Baumann and Charleen Knapp
The modern mortgage market offers a variety of mortgage loans catering to the needs of homebuyers. The titles and details of these plans can become confusing, especially as new types are introduced continuously. You can make sense of these loan types, however, if you understand the basic principles that govern all mortgage loans. Basic Principles of all Mortgage Loans - The home is used as security to back up the loan.
- A lender can force sale of the home if the borrower defaults by failing to make scheduled payments.
- The larger the loan compared to the value of the home, the more risky for the lender and, often, the more expensive the loan will be.
- Interest earned by the lender always is equal to the periodic interest rate times the outstanding principle balance of the loan. The periodic interest rate is the annual interest rate divided by the number of payments in the year (usually one per month).
- The required payment usually is a bit larger than the interest due so that some of the loan principal is repaid with each payment. This process is called amortization and is why most mortgage loans can be retired when all the monthly payments have been made.
Also, it helps to know that all mortgage loans have one of the following features: As you learn more about the types of financing available, you will notice that some loans appear to have more favorable terms. That may indicate that those loans are, indeed, bargains (and it does pay to shop around), but usually it means that those loans have some feature that is less appealing to borrowers. For example, shorter-term loans often have slightly lower interest rates compared to longer-term loans. However, the monthly payment for the same amount of principal may be higher because of the shorter term. Variable rate loans usually have much lower interest rates to compensate for the risk the borrower accepts that interest rates will rise in the future. You may want to choose a loan type based on what you consider your largest problem in arranging financing. - Reduced down payment loans. Often, people who buy their first home or those who have never been successful in accumulating a substantial equity in their previous homes have trouble with the standard down payment.
- Reduced monthly payment loans. Another problem for first-time buyers and others is insufficient income to qualify for a loan large enough to buy the home. Because the lender’s qualifying formula compares income to payment amount, insufficient income calls for loans with reduced monthly payments.
- Quicker pay-off loans. Appeal to borrowers who are concerned with the total costs of the loan.
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