A mortgage is a loan that a bank or that a mortgage lender gives you to help you finance the purchase of your home. The loan is secured by the collateral of the property you are purchasing. Mortgages are usually paid back over years and are most commonly done in monthly set payments. If payments are made towards a mortgage, the bank can foreclose on the property and sell the property to make up for their mortgage debt.
A mortgage payment is made up of four different components. These components are:
- Taxes, and
Principal is the total amount of money that you borrowed to buy the home or property. The principal can also be the remaining amount due. For example, if you took out a $500,000 loan, the initial principal is $500,000. However, after you pay off the first $100,000 the remaining $400,000 is now the principal. Interest is the amount of money that the lender or the bank will receive for making the loan. Lower interest rates, means lower mortgage payments and vice versa. Taxes are, well, taxes. They are the property tax that you will be paying as the home/property owner. They are usually calculated based on the value of your property. And finally, insurance. There are two types of insurance that could be included in the mortgage payments. The first is property insurance which protects the home from fire, theft, and other potential disasters and the second is private mortgage insurance (PMI). If your down payment on a home is less than 20%, then you will need to get private mortgage insurance, to protect the lender if you default on your mortgage.
The traditional mortgage is a fixed mortgage, which is, you guessed it, fixed. Which means that the person paying back the mortgage pays a fixed rate from the beginning of the mortgage all the way until the end. A fixed mortgage is made up of:
- the amount of the loan,
- the interest rate,
- compounding frequency, and
- the duration of the mortgage.
The amount of the loan and the duration will obviously vary from mortgage to mortgage and will depend on what you’re looking for. The interest rate is the amount of interest due each period as a proportion of the amount of the mortgage. And compounding frequency is the addition of the interest to the principal sum of the mortgage loan you decide to take out. There are other types of mortgages, such as interest only or adjustable rate mortgage but fixed mortgages are the most common.
Mortgages can be a daunting, long term commitment so it would be advised to fully understand the structure and components of a mortgage before jumping in. Take into consideration the size, the time frame, and your finances to select the best mortgage for you. Though they can be overwhelming, mortgages have been an essential tool in helping individuals become homeowners.