Individuals and businesses use mortgages to make large real estate purchases without paying the entire purchase price up front. Over many years, the borrower repays the loan, plus interest, until she or he owns the property free and clear. Mortgages are also known as "liens against property" or "claims on property." If the borrower stops paying the mortgage, the lender can foreclose. They are a form of incorporeal right.
Mortgages come in many forms. The most popular mortgages are a 30-year fixed and a 15-year fixed. Some mortgages can be as short as five years; some can be 40 years or longer. Stretching payments over more years reduces the monthly payment but increases the amount of interest to pay.
With a fixed-rate mortgage, the borrower pays the same interest rate for the life of the loan. The monthly principal and interest payment never changes from the first mortgage payment to the last. If market interest rates rise, the borrower’s payment does not change. If interest rates drop significantly, the borrower may be able to secure that lower rate by refinancing the mortgage. A fixed-rate mortgage is also called a “traditional" mortgage.
With an adjustable-rate mortgage (ARM), the interest rate is fixed for an initial term then fluctuates with market interest rates. The initial interest rate is often a below-market rate, which can make a mortgage more affordable in the short term but possibly less affordable long-term. If interest rates increase later, the borrower may not be able to afford the higher monthly payments. Interest rates could also decrease, making an ARM less expensive. In either case, the monthly payments are unpredictable after the initial term.
Mortgages are used by individuals and businesses to make large real estate purchases without paying the entire purchase price up front.
Other less common types of mortgages, such as interest-only mortgages and payment-option ARMs, can involve complex repayment schedules and are best used by sophisticated borrowers. Many homeowners got into financial trouble with these types of mortgages during the housing bubble of the early 2000s.
Most mortgages used to buy a home are forward mortgages. A reverse mortgage is for homeowners 62 or older who look to convert part of the equity in their homes into cash. These homeowners borrow against the value of their home and receive the money as a lump sum, fixed monthly payment, or line of credit. The entire loan balance becomes due and payable when the borrower dies, moves away permanently, or sells the home.1
Among major banks offering mortgage loans are Wells Fargo, JPMorgan Chase, and Bank of America. Banks used to be virtually the only source of mortgages. Today a burgeoning share of the lender market includes non-banks such as Quicken Loans, loanDepot, SoFi, Calber Home Loans, and United Wholesale Mortgage.
When shopping for a mortgage, it is beneficial to use a mortgage calculator to get an idea of the monthly payments. These tools can also help calculate the total cost of interest over the life of the mortgage, to give you a clearer idea of what a property will really cost.
The mortgage servicer may also set up an escrow account, aka an impound account, to pay certain property-related expenses. The money that goes into the account comes from a portion of the monthly mortgage payment.2
Lenders sometimes require that escrow be used to pay taxes and insurance, according to the U.S. Consumer Financial Protection Bureau.
Mortgages, perhaps more than any other loans, come with a lot of variables, starting with what must be repaid and when. Homebuyers should work with a mortgage expert to get the best deal on what may be one of the biggest investments of their lives.
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