General Question

f4a's avatar

How does a mortgage work?

Asked by f4a (601 points ) June 17th, 2009

Is it a contract? Does it have interest? Please explain from the very basic part.

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12 Answers

Lupin's avatar

This is a good explanation. Mortgage Loan
It is a loan, usually for property, where the lender holds the property for collateral until the loan is paid in full.

There are all kinds of mortgage loans but the vast majority are as described above.
And, oh yes, there is interest. That is why the lender is willing to give you money.

dalepetrie's avatar

It is a loan, it is a contract, it does have interest. Basically, a house costs say $200,000….you don’t have that kind of cash. You borrow most of the money from a bank. The bank actually buys the house and lets you live in it, they own it, but you contract with them to essentially buy the loan from them by paying them part of what you owe them every month, plus interest. that’s as basic as it gets.

Urban's avatar

be sure to look up the differences between a mortgage and a trust deed. most “mortgages” in california and a few other areas are actually trust deeds, whereas the majority of the country uses mortgages.

walterallenhaxton's avatar

You work backwards form the payment. How much can you afford as a payment? Include other regular expenses in that. That determines the amount you can borrow at the offered interest rate. You also need to determine the time of the loan. If it is longer term you will pay more but the payment will be less. So if you want to get a bigger loan you need to go longer term. That payment is pretty much trapped with in your afordability range. It tells you what price range of properties you can afford and that is the way it works. Get yourself a rate book or a good business calculator and figure away.

RareDenver's avatar

There are also of course Interest Only Mortgages. This is where you borrow the money to buy the property, say £200,000 and each month you only pay back the interest on the loan and none of the actual loan itself, at the end of the mortgage period, say 20 years you then have to pay back the sum borrowed £200,000. Most lenders would like to see proof of some kind of investment vehicle i.e. an endowment that you have running alongside the mortgage to ensure you can pay back the capital lump sum at the end. The advantage to this is that your Investment Vehicle may over perform and you have for example £240,000 at the end of the term and have an extra £40,000 in your pocket. The downside of course is that it may under perform and you only have £160,000 at the end of the term and have to find an extra £40,000 to pay off the loan.

You would certainly monitor the performance of your endowment over the term and if it looked like there was a shortfall you would need to increase your regular payments into it.

juwhite1's avatar

Another piece of information to keep in mind… On traditional mortgages, your first payments are almost entirely interest, and gradually the proportion of principal on the payments increases until you last payments are almost entirely principal. On these loans, it is very important to pay extra on the principal, especially early in the mortgage’s life, to reduce the overall cost of the loan significantly.

walterallenhaxton's avatar

@juwhite1 I wish that the world worked that way. The first think a new homeowner things of doing is furnishing his new house. By the time he does that the car needs help. After about 10 years he thinks about paying down the mortgage. The best that it is really practical to do is to keep the term of your mortgage to 15 years. That accomplishes what you are saying. The payments are not greatly higher. The current market prices for houses are still high. Waiting and renting would help a lot.

YARNLADY's avatar

@dalepetrie If the bank bought the house and let you live in it, they would have to pay the taxes and such. Instead, they lend you the money, let you pay all the owners fees and taxes, and then if you don’t pay them back the money they loaned you, plus interest, they can take ownership of the house away from you through foreclosure.

You own the house from the very start, and you pay for the insurance, the taxes, the community assessments, the upkeep and all the other owner expenses, and you also have the right to change anything you want, within the local zoning requirements, and the right to sell it to someone else, or let someone else live in it.

dalepetrie's avatar

@YARNLADY – legally speaking, that’s how it’s set up. Practically speaking however the bank has more ownership rights than you do if they ever sought to exert them. The legal term is “secured party”. Yes, you own the house (and hence can do what you want with it and have to pay all the liabilities associated with it), but your equity, i.e. the portion you ACTUALLY own is the difference between what the house is worth and what you owe on it. That’s what you really own is the equity in the home, which combined with physical possession is what makes it an “ownership” situation. But let’s say you owe $25k on a house that’s worth $300k, you have $275k in equity. But let’s say that you originally owed $175k and paid it down to that point, even though the bank has gotten $150k plus probably another $150k in interest from you over the years, let’s say you miss 3 payments in a row, @ $1,200 a pop. Because you are late on $3,600 in payments on a $25k loan, they can take that entire $300k house from you. Who really owns the house? I’m not talking legally or technically, I’m talking realistically?

YARNLADY's avatar

@dalepetrie As a homeowner, I can assure you that owning a home means much more than owing money to a lender. Yes, if you default on the agreement you make to pay them back, they can take away the home. But, as long as you honor your agreement, they cannot come on your property without your permission, they cannot tell you what color your new roof has to be, they cannot choose what plants to put in your yard, they cannot tell you you can’t have a pet or two or three.

dalepetrie's avatar

All true, but push comes to shove in court, you’ll see who really “owns” the home, that’s all I’m saying. I’m well aware of everything you say and don’t disagree with you, just making a point.

LostInParadise's avatar

Most mortgages are fixed rate and have fixed monthly payments. Assuming that the home owner intends to pay off the mortgage within a specified period of time, the payments are usually set up as a fixed amount of money paid each month. The payment includes interest and a payback of part of the loan. The interest portion of the payment will be larger at the beginning because there is more principal to pay interest on. Toward the end of the loan period, most of the monthly payment will be to pay off the principal. There is a calculation that is done that determines the amount of the monthly payment required so that everything works out so that the final payment includes the last part of the principal plus the interest on it.

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