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What is a mortgage?
By Bankrate.com
A mortgage is a long-term loan that a borrower obtains from a bank, thrift, independent mortgage broker, online lender or even the property seller. The house and the land it sits on serve as collateral for the loan. The borrower signs documents at closing time giving the lender a lien against the property. If that borrower doesn't make payments as agreed, the lender can take the home through foreclosure.
Pay out over time
Because mortgages are such large loans, consumers pay them off over long periods -- usually 15 to 30 years. Their monthly payments gradually whittle away the principal balance.
A monthly mortgage payment is sometimes called a PITI payment. That's because each one covers a portion of the following four costs:
1.Principal -- the loan balance
2.Interest -- interest owed on that balance
3.Real estate taxes -- taxes assessed by different government agencies to pay for school construction, fire department service, etc.
4.Property insurance -- insurance coverage against theft, fire, hurricanes and other disasters
Borrowers can choose to pay their real estate taxes and insurance in lump sums when they come due, rather than in monthly installments to their escrow accounts. Depending on the kind of mortgage a borrower has, the monthly payment may also include a separate levy for private mortgage insurance (PMI) or government-backed mortgage insurance premiums.
The breakdown of each payment (the amount that goes toward principal, interest, etc.) changes over time because mortgages are based on a repayment formula called amortization. That's a fancy term meaning the lender spreads the interest you owe on the mortgage over hundreds of payments so that the overall loan is as affordable as possible.
How does amortization work? Here's how the principal and interest change over the life of a loan:
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Here's how the principal and interest change over the life of a loan
(30-year, 7.5% fixed-rate mortgage of $150,000) |
| Payment Number |
Principal Balance |
Payment Amount |
Intrest Paid |
Principal Applied |
New Balance |
| 1 |
$150,000 |
$1,048.82 |
$937.50 |
$111.32 |
$149,888.68 |
| 60 |
$142,086.93 |
$1,048.82 |
$888.04 |
$160.78 |
$141,926.15 |
| 120 |
$130,426.14 |
$1,048.82 |
$815.16 |
$233.66 |
$130,192.48 |
| 240 |
$88,815.22 |
$1,048.82 |
$555.32 |
$493.50 |
$88,357.72 |
| 359 (next to last) |
$2,078.14 |
$1,048.82 |
$12.99 |
$1/035.83 |
$1,042.30 |
| Source: Bankrate.com |
On a 30-year, $150,000 mortgage with a fixed interest rate of 7.5 percent, a homeowner who keeps the loan for the full term will pay $227,575.83 in interest. The lender can't possibly expect that person to pay all that interest in just a couple of years, so the interest is spread over the full 30-year term. That keeps the monthly payment at $1,048.82.
But the only way to keep the payments stable is to have the majority of each month's payment go toward interest during the early years of the loan. Of the first month's payment, for instance, only $111.32 goes toward principal. The other $937.50 goes toward interest. That ratio gradually improves over time, and by the second-to-last payment, when we're all driving hovercars and have colonized the moon, $1,035.83 of the borrower's payment will apply to principal while just $12.99 will go toward interest.
Pre-Qualified or Pre-Approved?
What’s the Difference?
There are three levels of services provided by mortgage lenders regarding basic qualifying for a mortgage. Pre-qualification, pre-approval and firm commitment are the three levels of services.
The pre-qualification process is very simple and takes about fifteen minutes. This can be done over the phone upon first contact with a mortgage lender. Basically, the loan originator will interview the potential borrower, asking questions regarding income, debts and assets. This type of qualification is preliminary and is subject to verification of income, credit rating, and assets. It is a good idea for a buyer to take this step before viewing homes for sale, to get an idea of the price range to look in.
The pre-approval process is a more detailed, formal procedure. The pre-approval involves an actual application form being completed and all the appropriate information and documents are gathered before the home is purchased. A full tri-merge credit report is obtained and the entire file is submitted to an underwriter for review. If acceptable, the approval is generally subject to a fully executed sales contract and a satisfactory appraisal of the home. The pre-approval gives both the buyer and seller peace of mind by alleviating the concern of a loan denial. Usually, a lender will collect a fee at the time of application to cover the cost of the full credit report and the fee may be credited toward closing costs.
Once an offer on a property has been accepted by the seller, a firm commitment for a mortgage can be issued to a borrower. This is done after an underwriter has reviewed all income, assets, debts and an appraisal. An additional fee is usually collected to apply toward the appraisal cost. Again, this fee it may be credited toward the closing costs.
When you are buying or selling a home, it is important to know the differences in these three types of services. Many misunderstandings are caused by buyer and seller interpretations of the meaning of these terms. They are not interchangeable! It is important that you make your home buying/selling decisions based upon an accurate understanding of the lending institution’s financial involvement.
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