Mortgages – What You Need to Know
Mortgage. The word is a daunting one- and with good reason. It’s a big step with many parts. But when buying a home, even a little bit of knowledge can be your friend.
Unless you are paying cash for your home, you will need a mortgage, which is essentially a loan that is secured by the property (collateral) you’re purchasing. You agree to pay back the lender/bank in monthly installments. The mortgage actually bundles together most of the necessary elements, including principal (the amount borrowed), interest, (property) taxes, and insurance. Private Mortgage Insurance (PMI) is also required on most loans until 20 percent of the equity is paid for (i.e. if you put 20 percent down, you will likely not have to pay PMI).
There are two basic types of mortgages – fixed rate and adjustable rate mortgages (ARM). Fixed rate loans are steady, predictable, and easy to plan your finances around. The ARM is initially lower, but can increase as the “adjustable rate” fluctuates and increases over the time of the loan.
Additional terms you will come across are:
- APR (Annual Percentage Rate) – the interest rate combined with closing costs and other fees).
- Points – Lenders charge points to cover closing costs or lower interest rates. These points can be split between the buyer and seller. One point is one percent of the amount financed.
- Amortization – the process of dividing the borrowed amount (plus interest) into equal payments over the life of the loan. Interest is generally paid off first, then the principal.
- Escrow – an account created by the lender where money is collected from mortgage payments to cover annual expenses. The lender then makes these payments for you from the account when the bills are due (property taxes, etc.).