A mortgage is a real estate loan that enables people to buy homes by making payments over a long period of time. Mortgage loans are usually paid back over a term of 30 years or 360 months. The loan amount is also called the principal which is the amount you borrow and must pay back. Interest is charged on the loan and that interest rate reflects the economic conditions that exist at the time the loan is originated.
Some loans have fixed interest rates which means they don’t change over the life of the loan and neither does the combined principal and interest part of your loan payment. Often your loan servicer will collect other expenses as part of your monthly payment. Those parts of your payment that the servicer collects from you to cover mortgage insurance, homeowners insurance and taxes may change so the total payment you send your servicer may change even with a fixed interest rate loan.
Other loans have adjustable rates which start out lower than the fixed rates being offered at a given time because the rate can adjust periodically. The lender is less exposed to risks from changes in the economy because the borrower takes part of the risk by agreeing to allow their payments to adjust over time in exchange for the lower interest rate now. However, the borrower with an adjustable rate will have to deal with changes to their rate and payments when there are changes in the market. Usually changes to an adjustable rate are related to changes in the “prime” rate or other industry index rate (Libor) that reflect the market. With an adjustable rate loan, your loan interest rate will be adjusted periodically to be at a certain number of percentage points above or below prime. Generally, borrowers try to refinance their loans before their adjustable rates increase above the fixed rates being offered. In most cases, borrowers can refinance when the loan amount they want to borrow is less than the current market value of their home. However, when the amount of the loan you need is greater than the current market value of your home, you will not be able to refinance easily. This can happen when real estate values go down after your home purchase or you have borrowed against the equity in your home.
Read about the mortgage loan types available
Mortgages are made by a variety of institutions:
- Lenders, which are banks that also take deposits
- Mortgage banks, do not take deposits
- Mortgage brokers, act as an agent and “sell”
a borrower’s loan to a lender at closing when
all papers are signed
Some people prefer to go to a bank they are familiar with for a mortgage, while others like the often more personal service they receive from a mortgage banker or broker. Costs are about the same with any of them. Mortgage brokers, like independent insurance agents, deal with many lenders to whom they can broker your loan. Banks and mortgage banks generally only offer their own loan programs.
Lenders usually sell the loans they make to investors, big companies like Fannie Mae and Freddie Mac, whose purpose is to put money back into the market so it can be re-lent for more people’s mortgages. They make their money from the interest you pay and their cost of money. They lose money rapidly when too many people do not make their monthly payments. Other investors include life insurance companies, pension funds and mutual funds – in other words, companies whose customers are people just like you.
It is a financial “circle of life” in the sense that people make loans possible with their savings, their retirement funds and their life insurance policies. When the economy is good and people make their loan payments, everyone benefits. When loans become delinquent and go into default, everyone suffers.
The mortgage itself is a legal paper that says your lender “holds” the property for you “in trust” until you have fully paid the loan balance due under your loan agreement, or promissory note. For this reason, the mortgage is also known in some states as a "deed of trust" or "trust deed".
Because of the size of the amount and the importance of the debt, both the mortgage and the note are written in precise legal language. They contain all the provisions of the agreement, including the number of payments due, the date they are due, what happens if you are late or miss a payment, whether it is a fixed rate or adjustable loan, and how often the payments will change, if at all.
If you do not make payments to your mortgage, you are considered delinquent. If you miss too many payments, you are deemed to be in default. Once your loan is in default, the lender can commence foreclosure proceedings in order to repossess the home and recover their money from its sale. All of this is to be found in your mortgage and note.
Loan types