The modern mortgage market offers a variety of mortgage loans catering to the needs of homebuyers. The titles and details of these plans can become confusing, especially as new types are introduced continuously. You can make sense of these loan types, however, if you understand the basic principles that govern all mortgage loans. Again, you can look to your real estate agent or loan officer for assistance.
Basic Principles of all Mortgage Loans
The home is used as security to back up the loan. A lender can force the sale of the home if the borrower defaults by failing to make scheduled payments.
The larger the loan compared to the value of the home, the riskier for the lender and, often, the more expensive the loan will be.
Interest earned by the lender always is equal to the periodic interest rate times the outstanding principle balance of the loan. The periodic interest rate is the annual interest rate divided by the number of payments in the year (usually one per month).
The required payment usually is a bit larger than the interest due so that some of the loan principal is repaid with each payment. This process is called Amortization and is why most mortgage loans can be retired when all the monthly payments have been made.
All mortgage loans have one of the following features:
Mortgages with a fixed payment and fixed interest rate are known as fixed-rate mortgages.
Mortgages with a fixed-rate but variable payment are known as graduated payment mortgages
Mortgages with a variable-rate and variable payment are known as adjustable rate mortgages
As you learn more about the types of financing available, you will notice that some loans appear to have more favorable terms. That may indicate that those loans are, indeed, bargains (and it does pay to shop around), but usually, it means that those loans could have some feature that is less appealing to borrowers. For example, shorter-term loans often have slightly lower interest rates compared to longer-term loans. However, the monthly payment for the same amount of principal may be higher because of the shorter term. Variable-rate loans usually have much lower interest rates to compensate for the risk the borrower accepts that interest rates will rise in the future.