Mortgages are loans used to finance the purchase of a home. It is a long-term loan that is typically paid off over 15 to 30 years. When you take out a mortgage, you will be required to make monthly payments to your lender, which will go towards paying off the loan principal and interest. In this article, we will discuss the basic components of a mortgage, including the mortgage principal, interest rate, and mortgage terms.
Mortgage Principal
Mortgage principal refers to the amount of money you borrow from your lender to finance your home purchase. This amount is typically expressed as a percentage of the home's purchase price. If you purchase a home for $200,000 and you take out a mortgage for 80% of the purchase price, your mortgage principal would be $160,000.
Interest Rate
Interest rates are the percentages of your mortgage principal you will be required to pay your lender as interest. This percentage is applied to the mortgage principal each month, and the amount of interest you pay will depend on the term of your mortgage. For example, if you have a 30-year mortgage with an interest rate of 3%, your monthly payment will be higher than if you had a 15-year mortgage with the same interest rate since you will be paying off the mortgage over a longer period.
Mortgage Terms
The mortgage terms refer to the length of time that you will be required to pay off your mortgage. While 15 years and 30 years are the most common mortgage terms, you can find mortgages with terms as short as ten years or as long as 40 years. The term of your mortgage will affect your monthly payment and the overall cost of your mortgage. For example, a 30-year mortgage will have lower monthly payments than a 15-year mortgage, but the overall interest rate will be higher.
Down Payment
A down payment is the amount you will need to put down upfront when you purchase your home. This amount is typically expressed as a percentage of the home's purchase price, and it is usually required by the lender as a way to reduce the risk of the loan. There is generally a correlation between a larger down payment and a smaller monthly payment. Nevertheless, if you are unable to make a large down payment, you may still be able to qualify for a mortgage by paying private mortgage insurance (PMI).
Private Mortgage Insurance (PMI)
Lenders require PMI when the borrower puts down less than 20% of the home's purchase price. As an additional monthly payment along with the mortgage principal and interest, PMI protects the lender should the borrower default. The cost of PMI is typically based on the size of the mortgage and the borrower's credit score.
Closing Costs
The closing costs are the fees associated with the purchase of a home, and they can include a wide variety of expenses such as title insurance, appraisal fees, and attorney's fees. Closing costs are typically paid at the closing of the home purchase, and they can be substantial. You should be aware of the closing costs that you will be responsible for paying when you take out a mortgage, as they increase the overall cost.
Fixed-Rate Mortgages and Adjustable-Rate Mortgages
There are two main types of mortgages: fixed-rate mortgages and adjustable-rate mortgages (ARMs). You'll make the same monthly payment throughout the term of a fixed-rate mortgage. This type of mortgage is a good choice if you want the stability of knowing what your monthly payments will be and intend to own your home for a long time.
An adjustable-rate mortgage (ARM) has an interest rate that can change over time. An ARM's interest rate is usually linked to a financial index, such as the rate on Treasury Bills, and it can change frequently. The interest rate on an ARM will start at a lower level than a fixed-rate mortgage, but it can increase over time, which can result in higher monthly payments. It's a good choice if you plan to sell your home within a few years.
Mortgage Pre-Approval
Before you begin shopping for a home, getting pre-approved for a mortgage is a good idea. Pre-approval means that a lender has reviewed your financial information and has determined that you are qualified to borrow a certain amount of money to finance the purchase of a home. Pre-approval can help you narrow down your home search to properties that are within your budget and it can also make you a more attractive buyer to sellers.
To get pre-approved for a mortgage, you will need to provide your lender with information about your income, assets, and credit history. Your lender will use this information to determine your debt-to-income ratio, which is a measure of your ability to make your monthly mortgage payments. Your lender will also review your credit score, which is a measure of your creditworthiness. A higher credit score will typically result in a lower interest rate on your mortgage.
Conclusion
Mortgages are long-term loans used to finance home purchases. Understanding mortgage principal, interest rate, terms, down payment, closing costs, and private mortgage insurance are all important components of a mortgage. There are also two main types of mortgages: fixed-rate mortgages and adjustable-rate mortgages (ARMs). Before you begin shopping for a home, it is a good idea to get pre-approved for a mortgage to narrow your home search and make yourself a more attractive buyer to sellers.
