Mortgages 101

  • August 4, 2016
  • By: Greenpath Financial Wellness

Understanding your mortgage and interest payments is important when you’re considering buying a home. Buying a house is one of the most important financial decisions you can make. Owning a home will impact your finances for many years. It will also help you build wealth.

Mortgage Lingo: Vocab List

mortgage is a loan to pay for a home. The lender pays for the house, and then you pay back them through a mortgage.

The principal is the amount you actually borrow to purchase the home.

Interest is the amount the bank charges you to use their money.

The lender can take possession of the house if you don’t make your payments. This is called foreclosure.

A mortgage usually takes 15-30 years to pay back the lender.  The amount of time is called the loan’s term.

Your monthly payment is principal and interest, plus taxes and insurance.

The total is then divided into equal payments over the life of the loan using a process called amortization. Your payments mostly pay toward interest early in the loan. More goes toward the principal later on.

Amortization Example

For example, if you borrow $100,000 with a 30-year loan at 7 percent interest, amortization will calculate your payments something like this:

First Payment$665$583$82$99,118
At 5 years$665$550$115$94,132
At 10 years$665$501$164$85,812
At 20 years$665$336$329$57,300
Last Payment$665$4$661$0

In this example, after 30 years you would have paid off the $100,000 you originally borrowed, but you also would have paid an additional $139,509 in interest.

Escrow. If you put less than 20 percent down on the loan, the bank considers it a little riskier and requires an escrow account. They pay your insurance and taxes from this account.

Private Mortgage Insurance (PMI). If your down payment is less than 20 percent of the purchase price, your lender will probably also require you to purchase PMI on your loan. PMI protects the lender in case of default. An additional amount is added into your monthly payment to account for PMI. When you have accrued 20% equity in your home, you may request to have PMI removed.

Fixed-Rate Mortgages

Fixed-rate mortgages are the most popular type of mortgage.  They offer the comfort of knowing your interest rate is locked in. The monthly mortgage payment amount remains the same for the entire term of the loan.  Here are some fast facts about fixed-rate mortgages:

  • If interest rates change, your mortgage payment won’t be affected. You know what your principal and interest payment will be for the term of the loan.
  • The interest rate may be higher than other types of loans.
  • Your monthly payment can change based on taxes and homeowner’s insurance.

Adjustable-rate mortgages (ARMs)

These often start with a lower interest rate and a lower monthly payment. But the interest rate can change during the life of the loan. Here are some fast facts about ARMs:

  • All ARMs have periods that limit when the interest rate can change. The interest rate doesn’t change for the first period.  This can range from 6 months to 10 years. After the first period, most ARMs adjust the interest rate from time to time.
  • The interest rate can change based on two factors: the index and the margin. Interest rate changes are based on an index that reflects the current market.  The margin is a percentage that is added to the index. Based on these two factors, the interest rate can change. So if the interest rate increases, your payment will increase.
  • All ARMs limit how much the interest rate changes over the life of your loan.
  • If interest rates are high when you get your mortgage and drop during an adjustment period, your monthly payment may decrease. But a decrease is unlikely. So don’t base your choice of mortgage on this.

Interest-Only Loans

Some lenders offer loans that allow you to pay only the interest on the loan during the first few years.  After that, you must repay both the principal and the interest.

Most mortgages interest-only payment plans have adjustable interest rates, which means the monthly payment will change over the term of the loan. How often these changes occur depends on the terms of your loan.

The interest-only payment period is typically between 3 and 10 years. After that, your monthly payment will increase even if interest rates stay the same or go down.  That is because you must pay back the principal as well as the interest.

Payment-Option ARM

Here, the interest rate is typically very low for the first 1 to 3 months. After that, the rate rises closer to that of other mortgages. Your monthly payments during the first year are based on the initial low rate. This means that if you only make the minimum payment, it may not cover the interest due. The unpaid interest is added to the amount you owe on the mortgage, resulting in a higher balance. This is known as negative amortization.

Keep in mind that with interest-only mortgages and payment-option ARMs, your payments may go up a lot when the payments adjust. Planning for the increased payment will be very important to your financial health.

This information can help you decide which type of mortgage might work best for your financial goals. Lenders have a variety of names for these loans.

Get help now. It’s free.

GreenPath’s certified housing counselors are here to help you with with the mortgage decision process. We can provide valuable information on securing a loan and staying out of debt in the future. Owning a home — or borrowing against it — is a big step in your financial journey. GreenPath’s housing counselors will empower you with the knowledge to reach your goals.

Call now to talk to a housing advisor