The Facts Behind a Mortgage

Many consumers often believe they understand the basics behind mortgages but sometimes neglect to truthfully ask themselves, “what is a mortgage and how does a mortgage work”? The industry lists the term ‘mortgage’ in many different ways, but there is only one true definition. Regardless of the amount of variations on the term, a mortgage is an agreement between a borrower and a bank to lend money in exchange for real property. In French, the term mortgage actually refers to a “death pledge” because the bank terminates the loan once it is paid off or foreclosed upon if the borrower does not pay the loan as agreed.

How Mortgages Work- Collateral

In a purchase home transaction, the property is the collateral. If a borrower fails to make payments agreed upon in the terms of the mortgage, the bank or lender repossesses the collateral, and the borrower remains liable for the balance of the loan until the bank terminates the loan. This is not to say the borrower is off the hook once a bank terminates the loan. The bank continues to pursue the borrower for the balance and reports the repossession or foreclosure to the three major reporting agencies, TransUnion, Experian and Equifax.

How Mortgages Work- Principal and Interest

The principal is the money borrowed to purchase a home or another form of real estate. The interest is the amount of money banks and lenders charge to secure the principal amount of the loan, which borrowers use to pay the seller of the home or property. In the world of interest, a borrower’s credit score, debt-to-income ratio, available assets and work history affect the amount of interest paid. For example, the higher a borrower’s credit score, the lower amount of interest the borrower can expect to pay through a lower interest rate.

Understanding Taxes

Most borrowers who secure financing to purchase a home most likely will pay taxes as part of their monthly mortgage payment. Cities and counties determine the amount of taxes borrowers pay based on the value of a borrower’s home. Every city and county in the United States has different tax rates. Borrowers pay their property taxes using an escrow account that lenders set up prior to final closing. In most instances, lenders require an escrow account for borrowers who paid less than 20 percent down on their home purchase.

Some Basics Behind Insurance

Borrowers will not receive a mortgage unless they possess home insurance. Home insurance protects borrowers in the event of weather damage, fire or other causes. A home insurance plan must be in place before a lender closes the deal. Banks often require borrowers to pay private mortgage insurance if they pay less than 20 percent down. Private mortgage insurance, known as PMI, protects banks and lenders in the event borrowers default on their loans.

The Mortgage Process

Borrowers must first apply for their financing through a standard application that most banks use, the 1003. Borrowers do not need to settle for the first bank where they apply. Borrowers who truly understand mortgages know the importance of shopping around, especially in today’s information era where technology allows consumers to easily shop for quality mortgages. Borrowers must compare interest rates to land the best mortgage.