What is a Mortgage?
Learn more about mortgages, mortgage rates, and mortgage terms.
“Mortgage rates are down!” Everyone with five minutes of research into mortgage rates is telling every person they know that now is the time and they NEED to go buy a house before the rates go up. But what is a mortgage? What are mortgage rates? How do I know what type of mortgage to get? “Go buy a house,” is nice and all, but how?! The first step is to understand what a mortgage is, and what type of mortgages are available.
According to the Consumer Finance Protection Bureau, a mortgage is “an agreement between you and a lender that gives the lender the right to take your property if you fail to repay the money you've borrowed plus interest.” Essentially, a mortgage is a specific type of loan used to purchase real estate or to borrow against real estate you already own. While a mortgage is viewed as a common type of loan, it is important to remember that it is still a type of debt, so you should be informed of all your options, risks, and payment expectations before taking out the loan.
Mortgage rates are how the interest due on a mortgage is calculated. The “rate” is the percentage of the loan you are required to pay above the original loan amount as interest. Rates are determined by the lender, based on the market averages and the borrower’s credit rating. Rates can be adjustable, meaning they change throughout the loan, or fixed, so they stay the same from year to year for the life of the loan. A lower rate is beneficial for the borrower, as it means the overall cost of the loan is lower.
The next important aspect of your mortgage is the loan term. The “term” of a loan is the total number of years you will be expected to make the minimum payment to pay back the loan and interest. Mortgage loans are traditionally offered in 15- or 30-year terms, though some lenders offer 10-,20-, and even 40-year terms. Shorter terms lead to quicker pay-offs, but also have higher minimum payments.
To illustrate how a mortgage works, let’s take a look at two potential loan options. You’ve decided to buy a home that is $250,000, and your 20% down payment is $50,000, so you’ll need a $200,000 loan.
For the first option, you qualified for a 3.92% interest rate on a 30-year mortgage. Your interest and principal payment will be $946/month for the next 360 months (30 years). The overall cost of your loan is $340,427; $140,427 in interest over 30 years. Add in the $50,000 down payment, and you paid nearly $400,000 for your $250,000 house.
The second option is the same 3.92% interest rate but on a 15-year mortgage. Your payment increases to $1,471 ($525 more), but your payments only last for 180 months. The overall cost of this loan is $264,847. That’s only $64,847 in interest! With this option, you’ve paid $314,847 for your $250,000 house, and it was paid off in half as much time. What would you do with the $75,000 you just saved, and 15 fewer years of mortgage payments?
I hope these explanations help you feel more confident when discussing mortgages and looking at your options when you purchase a home. Next week, I’ll address the types of mortgages available, the pros and cons of each, and which I recommend for my clients. If you have questions about money management or mortgages, you can always book a one-on-one meeting with a financial coach on the “schedule” page of our website at www.endeavorfinancialcoaching.com/schedule.