Find Out the Truth About a Mortgage
Most of us are familiar with the word "mortgage," especially in the aftermath of the 2008 housing collapse. All kinds of people regularly toss it around in blogs and other online fora. But if you're not a homeowner yourself, do you really understand what a mortgage means?
The simplest and most common definition of "mortgage" is a loan for a house or other piece of real estate in which the real estate is pledged as collateral. That means that, if you default on the loan, the real estate can be taken back by the lender and sold to fulfill the terms of the loan. This is in contrast to most ordinary personal loans such as credit cards, in which the things you buy with them cannot be taken back by the bank if you default on your loan.
There are many different kinds of mortgages. Some have an interest rate that remains fixed throughout the life of the loan, while others have an adjustable rate which can be changed every six months according to what certain indicators in the housing market are doing. Although the standard term of a mortgage is 30 years, it is possible to get mortgages as short as 15 years and as long as 40 years.
During the height of the housing bubble, some very risky loan options became common. These included interest-only loans, low-doc and no-doc loans (in which you didn't even have to demonstrate your earnings, an option favored by people who owned their own businesses or were self-employed and thus had trouble bipping the boxes of a standard loan application even if they had substantial income), and loans in which the buyer got to decide how much to pay each month. However, because so many of these loans were taken out by people who really weren't able to pay them back over the long term, financial institutions have tightened up the rules a lot and most of them are not available any more.
Other terms often heard in connection with mortgages are escrow and private mortgage insurance (PMI). Escrow refers to funds that are held to pay property taxes and hazard insurance. Because the bank doesn't want to risk having the property seized by the county while you are still paying on it, simply because you neglected to pay your property taxes, and because they want to make sure that your property is properly insured against damage by fire, weather or other disasters that might leave it uninhabitable, you will be required to pay an additional sum on top of principal and interest each month. This sum is put in an escrow account, from which property taxes and hazard insurance premiums will be paid.
Private mortgage insurance should not be confused with hazard insurance. It is entirely for the protection of the lender, and is usually required if you cannot put at least 20% down when you buy the house. Although PMI can be assessed in a lump sum as part of the closing costs, it typically is paid each month as part of the monthly payment.
Because mortgages are more complex than ordinary personal loans, cover a far longer term, and involve a much larger amount of money, it is absolutely essential to understand what is involved in them so that you don't get painful surprises months or years later.
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