Almost every American has a mortgage for their house. Although millions of Americans have a mortgage, many do not know what exactly a mortgage is. To ensure that everyone has a clear understanding of one of the most crucial financial topics, FME Finances has written a detailed and easy-to-understand article on:
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What Is a Mortgage?
A mortgage is a type of loan that allows one to buy or refinance a home when he or she cannot/does not wish to pay the total cost of the house in a single transaction.
A mortgage is a loan, but a loan is not a mortgage. A loan covers any financial transaction where money is given from one party to another, with the agreement of paying it back with interest. A mortgage is a specific type of loan that exclusively involves a property.
Even after meeting strict requirements, the borrower must put the mortgaged property as collateral to provide additional security. In simple terms, this means that when you take out a mortgage, your house becomes the collateral.
A collateral is an asset that a lender accepts when giving a loan. This collateral serves as security and a form of protection that you will repay the loan. Typically whatever you purchase using the loan is used as collateral. For example, if you get a car loan to buy a Mercedes-Benz S-Class, then that Mercedes that you bought will be collateral.
So what happens if you don't pay your mortgage? This is where the collateral is useful to lenders.
If you discontinue paying the monthly payments of the mortgage, the lender can enforce foreclosure. Foreclosure is a procedure that terminates the mortgage agreement, causing the property to be seized from your possession.
A mortgage is a loan, but a loan is not a mortgage. A loan covers any financial transaction where money is given from one party to another, with the agreement of paying it back with interest. A mortgage is a specific type of loan that exclusively involves a property.
Even after meeting strict requirements, the borrower must put the mortgaged property as collateral to provide additional security. In simple terms, this means that when you take out a mortgage, your house becomes the collateral.
A collateral is an asset that a lender accepts when giving a loan. This collateral serves as security and a form of protection that you will repay the loan. Typically whatever you purchase using the loan is used as collateral. For example, if you get a car loan to buy a Mercedes-Benz S-Class, then that Mercedes that you bought will be collateral.
So what happens if you don't pay your mortgage? This is where the collateral is useful to lenders.
If you discontinue paying the monthly payments of the mortgage, the lender can enforce foreclosure. Foreclosure is a procedure that terminates the mortgage agreement, causing the property to be seized from your possession.
Who Can Get a Mortgage?
One thing to remember is that not everyone can get a mortgage. One must meet specific requirements to qualify for a mortgage.
In order to ensure that the loanee is able to meet the mortgage payment deadlines, mortgages are usually only given to people who have a stable income, good credit score, a debt-to-income ratio of less than 50%, and enough money to pay at least 3% down payment.
Besides the requirements stated above, the primary aspect that is taken into consideration is whether the borrower can reasonably afford it or not.
The exact requirements vary from loaner to loaner.
In order to ensure that the loanee is able to meet the mortgage payment deadlines, mortgages are usually only given to people who have a stable income, good credit score, a debt-to-income ratio of less than 50%, and enough money to pay at least 3% down payment.
Besides the requirements stated above, the primary aspect that is taken into consideration is whether the borrower can reasonably afford it or not.
The exact requirements vary from loaner to loaner.
How Do Mortgages Work?
In simple terms, a mortgage follows the same procedure as a loan, but it pertains to homes. The loanee receives the amount of money needed to buy the house while agreeing to pay back the loan with interest over a set amount of years.
All loans require the borrower to repay the lender, but with interest (this is how the lender benefits from this financial transaction). The interest rate is determined by current market rates (determined by the Federal Reserve, which is out of the borrower's control) and the amount of risk involved (determined by the borrower's credentials such as their credit score).
The only way the borrower can reduce the interest rate is by modulating the level of risk involved. If the borrower has positive records and a low debt-to-income ratio, the lender will feel as if the loan involves lower risk, resulting in a lower interest rate. There is always some level of risk; therefore, the interest rate is never 0%.
Moreover, although you may find this surprising, the borrower only owns the house once the mortgage is completely paid off. This is because prior to it being completely paid off, the owner is still putting money towards completely purchasing the house. For example, if you decide to purchase an iPhone by paying in installments, the iPhone is not yours until you pay it off completely.
However, if you're planning on selling your house, don't be disappointed. You can STILL sell the house even if you have not paid off the mortgage. In fact, it is not uncommon to see people selling their house just so they can pay off their mortgage sooner. This works because you can sell your house and use the money towards paying off your mortgage.
If this is what you have in mind, make sure to sell your house for a price higher than your remaining mortgage. Nevertheless, if the selling price of your house falls short of the value of your remaining mortgage, you will have to cover the difference .
All loans require the borrower to repay the lender, but with interest (this is how the lender benefits from this financial transaction). The interest rate is determined by current market rates (determined by the Federal Reserve, which is out of the borrower's control) and the amount of risk involved (determined by the borrower's credentials such as their credit score).
The only way the borrower can reduce the interest rate is by modulating the level of risk involved. If the borrower has positive records and a low debt-to-income ratio, the lender will feel as if the loan involves lower risk, resulting in a lower interest rate. There is always some level of risk; therefore, the interest rate is never 0%.
Moreover, although you may find this surprising, the borrower only owns the house once the mortgage is completely paid off. This is because prior to it being completely paid off, the owner is still putting money towards completely purchasing the house. For example, if you decide to purchase an iPhone by paying in installments, the iPhone is not yours until you pay it off completely.
However, if you're planning on selling your house, don't be disappointed. You can STILL sell the house even if you have not paid off the mortgage. In fact, it is not uncommon to see people selling their house just so they can pay off their mortgage sooner. This works because you can sell your house and use the money towards paying off your mortgage.
If this is what you have in mind, make sure to sell your house for a price higher than your remaining mortgage. Nevertheless, if the selling price of your house falls short of the value of your remaining mortgage, you will have to cover the difference .
What Is the Exact Procedure of Paying a Mortgage?
The borrower receives a principal amount (the amount that is loaned without the interest). The borrower agrees to pay a portion of their monthly income to the loaner. This monthly payment is directed towards paying off the principal amount plus interest.
The money that goes towards the principal amount builds the borrower’s equity.
Home equity is the value of your ownership of your house. Your home equity is determined by taking the difference between the fair market value of your house and the value of your unpaid mortgage. To get the most accurate results, use a home equity calculator. We recommend Bank of America's calculator or Bankrate's calculator.
Home equity is essential because it makes more financing options available. Furthermore, when applying for a loan (not a mortgage), your home equity will make it easier for your loan to be approved.
Additionally, the lender is restricted to only lending as much money-or less-as the appraised value of the house. The appraised value of a house is the house's fair market value. In simple terms, all this means is that the amount of money lended cannot exceed the house's fair market value. Although this may seem intuitive, it is important to know this so that you do not get involved in any legal affairs.
Now that you have all the necessary general knowledge of how to pay a mortgage, let's answer a very common question: "Can you pay your mortgage with credit card?"
The short answer is yes, you can pay your mortgage with a credit card. However, most of the time, mortgage lenders don't accept direct credit card payments. Because of this, you will have to pay with a third party, such as a payment processing service known as Plastiq. The downside of this is that Plastique charges a 2.85% fee.
Although this may sound like a small percentage, it becomes hefty as mortgages are worth a lot. For example, paying a mortgage of $500,000 with a credit card would result in an increase of $14,250. This would bring your total payment to %514,250. Therefore, we do not recommend paying your mortgage with your credit card.
Including a mortgage in your personal financial plan is necessary. If you do not know what a personal financial plan is, click here. Meanwhile, if you do not know how to devise your financial plan, click here.
The money that goes towards the principal amount builds the borrower’s equity.
Home equity is the value of your ownership of your house. Your home equity is determined by taking the difference between the fair market value of your house and the value of your unpaid mortgage. To get the most accurate results, use a home equity calculator. We recommend Bank of America's calculator or Bankrate's calculator.
Home equity is essential because it makes more financing options available. Furthermore, when applying for a loan (not a mortgage), your home equity will make it easier for your loan to be approved.
Additionally, the lender is restricted to only lending as much money-or less-as the appraised value of the house. The appraised value of a house is the house's fair market value. In simple terms, all this means is that the amount of money lended cannot exceed the house's fair market value. Although this may seem intuitive, it is important to know this so that you do not get involved in any legal affairs.
Now that you have all the necessary general knowledge of how to pay a mortgage, let's answer a very common question: "Can you pay your mortgage with credit card?"
The short answer is yes, you can pay your mortgage with a credit card. However, most of the time, mortgage lenders don't accept direct credit card payments. Because of this, you will have to pay with a third party, such as a payment processing service known as Plastiq. The downside of this is that Plastique charges a 2.85% fee.
Although this may sound like a small percentage, it becomes hefty as mortgages are worth a lot. For example, paying a mortgage of $500,000 with a credit card would result in an increase of $14,250. This would bring your total payment to %514,250. Therefore, we do not recommend paying your mortgage with your credit card.
Including a mortgage in your personal financial plan is necessary. If you do not know what a personal financial plan is, click here. Meanwhile, if you do not know how to devise your financial plan, click here.
How the Interest Rate Changes During a Mortgage
At the beginning of a mortgage, the interest rate is high, causing less money to go towards paying off the principal amount and more towards paying the interest.
The interest rate is inflated at the beginning because the amount still owed is remarkably close to the principal amount. Nevertheless, as time progresses, the interest rate starts to decline, causing more money to be used towards paying the principal amount rather than paying the interest. The interest rate declines as time progresses because the amount still unpaid decreases.
Nevertheless, as time progresses, the interest rate starts to decline, causing more money to be used towards paying the amount rather than paying the interest. The interest rate declines as time progresses because the principal amount is decreasing.
For instance, if the interest rate is 2.5% on a $500,000 mortgage, one will have to pay approximately $12,500 in just interest in the first month. However, after a few years, once the principal amount is $350,000 due to monthly payments, one will only have to pay $8,750 in interest. (The interest rate decreased because 2.5% of $500,000 is greater than 2.5% of $350,000)
The reduction in the interest allows a greater portion of the monthly payments to be used towards paying off the principal amount.
Note: the amount of each monthly payment used for interest rate vs. principal amount is different for every loan. The calculations done above are simple and most likely do not apply to your mortgage. To find the accurate distribution of your monthly payments, talk to your lender or use a reliable calculator.
This entire process is known as amortization.
The interest rate is inflated at the beginning because the amount still owed is remarkably close to the principal amount. Nevertheless, as time progresses, the interest rate starts to decline, causing more money to be used towards paying the principal amount rather than paying the interest. The interest rate declines as time progresses because the amount still unpaid decreases.
Nevertheless, as time progresses, the interest rate starts to decline, causing more money to be used towards paying the amount rather than paying the interest. The interest rate declines as time progresses because the principal amount is decreasing.
For instance, if the interest rate is 2.5% on a $500,000 mortgage, one will have to pay approximately $12,500 in just interest in the first month. However, after a few years, once the principal amount is $350,000 due to monthly payments, one will only have to pay $8,750 in interest. (The interest rate decreased because 2.5% of $500,000 is greater than 2.5% of $350,000)
The reduction in the interest allows a greater portion of the monthly payments to be used towards paying off the principal amount.
Note: the amount of each monthly payment used for interest rate vs. principal amount is different for every loan. The calculations done above are simple and most likely do not apply to your mortgage. To find the accurate distribution of your monthly payments, talk to your lender or use a reliable calculator.
This entire process is known as amortization.
The 2 Parties
Mortgages would be non-existent if lenders and borrowers/loanees did not exist.
Mortgagee (Lender)
A mortgagee is a financial institution, such as a bank, an online mortgage company (make sure it’s trusted), or a credit union. It is sheerly up to the lender whether he or she wants to give a mortgage to a mortgagor or not.
Although quite obvious, without lenders, borrowers would be unable to get enough money to buy houses. Therefore, lenders play a crucial role in mortgages.
Although quite obvious, without lenders, borrowers would be unable to get enough money to buy houses. Therefore, lenders play a crucial role in mortgages.
Mortgagor (Borrower/Loanee)
A borrower is someone who is seeking to buy a home using a loan from a lender.
There may be multiple co-borrowers applying for the same mortgage. Having more borrowers applying for the same mortgage increases the chances of qualifying for a mortgage because there are more incomes, which reduces the amount of risk.
Borrowers are the reason why mortgages, and any other loan, exist. If borrowers did not have the necessity to borrow money to pay for their houses, there would be no one to ask for mortgages.
There may be multiple co-borrowers applying for the same mortgage. Having more borrowers applying for the same mortgage increases the chances of qualifying for a mortgage because there are more incomes, which reduces the amount of risk.
Borrowers are the reason why mortgages, and any other loan, exist. If borrowers did not have the necessity to borrow money to pay for their houses, there would be no one to ask for mortgages.
Summary
Mortgages are one of the most common loans, which almost everyone has taken at one point in their lives. Because of how common they are, mortgages should be a familiar concept to everyone.
Mortgages are undoubtedly essential as they give millions of people the opportunity to buy a home.
Mortgages are undoubtedly essential as they give millions of people the opportunity to buy a home.
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Works Cited
Bank of America. “Learn About Home Equity.” Bank of America, https://www.bankofamerica.com/mortgage/learn/how-to-calculate-home-equity/. Accessed 28 June 2021.
Ceizyk, Denny, and Deborah Kearns. “Minimum Mortgage Requirements for 2021.” LendingTree, 21 December 2020, https://www.lendingtree.com/home/mortgage/minimum-mortgage-requirements/. Accessed 27 June 2021.
Consumer Financial Protection Bureau. “How does paying down a mortgage work?” Consumer Financial Protection Bureau, 05 August 2016, https://www.consumerfinance.gov/ask-cfpb/how-does-paying-down-a-mortgage-work-en-1943/. Accessed 26 June 2021.
Rocket Mortgage. “What Is A Mortgage? Loan Basics For Beginners.” Rocket Mortgage, Quicken Loans, 17 June 2021, https://www.rocketmortgage.com/learn/what-is-a-mortgage. Accessed 26 June 2021.
Ceizyk, Denny, and Deborah Kearns. “Minimum Mortgage Requirements for 2021.” LendingTree, 21 December 2020, https://www.lendingtree.com/home/mortgage/minimum-mortgage-requirements/. Accessed 27 June 2021.
Consumer Financial Protection Bureau. “How does paying down a mortgage work?” Consumer Financial Protection Bureau, 05 August 2016, https://www.consumerfinance.gov/ask-cfpb/how-does-paying-down-a-mortgage-work-en-1943/. Accessed 26 June 2021.
Rocket Mortgage. “What Is A Mortgage? Loan Basics For Beginners.” Rocket Mortgage, Quicken Loans, 17 June 2021, https://www.rocketmortgage.com/learn/what-is-a-mortgage. Accessed 26 June 2021.