How Do Mortgages Work
A mortgage is a real estate loan that you take out when you want to buy a house. Mortgages are a type of loan system where there is a specified time period of repayment, and the purchased property acts as collateral. Typically, mortgages come with a fixed rate and need to be paid off within 15 to 30 years. It is a secured loan because the borrowing of money is secured on the property. If you fail to keep up the repayments, the bank can take possession of the property to get back their money's worth. This process of taking your property is termed as a Foreclosure.
When you take a mortgage, the money you borrow is called the capital and the lender lends you a percentage of the value of the property. You can borrow up to 95% of the total value of the property and pay the rest from your own savings. After you purchase the property, the lender secures the property as collateral and charges an interest until the loan is repaid fully. According to the type of mortgage that you apply for, there will be a repayment method of only interest or interest and capital. The time period to repay the loan is typically 25 to 30 years.
Two ways that you can structure your loan:
1. Repayment mortgage.
With this structure, you can pay the interest and a part of the capital every month. The monthly payment consists of an amount from the actual mortgage loan and the interest that the bank has charged. As the years pass by and you continue to repay your mortgage, the interest reduces and at the end of the term, usually 25 years, you would've managed to repay your loan and own your home.
2. Interest-only Mortgage.
Here you pay only the interest on the loan and nothing off the capital. Since you do not pay part of the capital, the amount you owe does not reduce. They are lower monthly repayments. Banks and lenders have reduced the possibility of offering this kind of loan because they are uncertain of whether the homeowners will be able to pay off their loan on time. At the end of the term, you need to repay the debts to avoid a foreclosure. You have to make a plan to pay off the loan. It is a more risky structure but reduces the amount you have to pay monthly.
After you have understood how to pay back the capital and interest, you need to choose a type of mortgage. Comprehending and figuring out how different types of mortgages work is important.
The different types of mortgages are listed below:
1. Fixed-rate Mortgages.
They offer a fixed rate of interest and a repayment term on 15, 20 or 30 years. The fixed rate does not increase even with the fluctuating market after you sign. It is a deal where you have committed to repaying the loan in the specified time period.
2. Adjustable Rate Mortgages.
This includes a mortgage where the interest rate can increase or decrease while you are repaying the loan. An increase in the market rate will invariably increase the amount you have to repay every month. It is still a popular type of mortgage, as banks also tend to reduce the rate of interest.
3. An offset mortgage.
Here, you link your savings to your mortgage. The more you save, you will decrease the mortgage balance and will, in turn, help you pay a lower rate of interest.
Most people choose a more conventional mortgage with a fixed or adjustable rate. There's a variety of other mortgages for special cases that require smaller amounts from borrowers.
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