Many people dream of owning their own home. Mortgages are tools that can make this possible by loaning the bulk of the cost. There are risks in acquiring a mortgage, but most people cannot afford a house without one.
The common usage of the word mortgage can be confusing. Technically it is a note that gives the lender the option to foreclose the property if the borrower does not keep up with the payments. Here, the common usage referring to the mortgage loan as the mortgage will be used.
The down payment plus the amount of the mortgage covers the cost of the property. The mortgage will usually have a specific term, for example 20 years. In most cases the mortgage is paid by that time.
In most cases, the loan will be amortized. This means that each month a payment is made that includes both interest and a portion of the principle, i. E., the balance due. An amortized loan is paid in full at the end of its term.
Non-amortized loans may also be used. This generally have a lump sum, called a balloon payment due at the end of the term. Where these loans are commonly used, it is also a common practice to set up an investment plan intended to accumulate enough money to cover the balloon payment. Many variations between fully amortized and non-amortized loans are possible.
The interest rate may be fixed, or it may not be. If it is fixed, then so is the payment, so life for the borrower is less uncertain. However, if rates go up during the term of loan, they may end up paying more to fund the loan than they are receiving in interest. This interest rate risk is moved to the borrower by a variable rate loan.
If the rate is variable, the loan documents will say how often it can change and give rules for setting it. For example, the rate might be based on the Treasury bill rate and it might change every year. In most cases there will be a highest possible rate specified.
Borrowers who fall behind on their payments have the risk of a foreclosure, where the lender takes the property and may sell it. Lenders will often try to work out problems like this, possibly by changing the loan terms. Another possibility is a short sale, where the property is sold for less than the loan balance and the lender agrees to take the loss. If the proceeds from a foreclosure sale are less than the amount due, the lender might have recourse against the lender. This issue is too complex to fully address here.
Mortgages open the door to home ownership for millions of people. Unfortunately some of these people will be ultimately unable to pay them off. Caution is always appropriate when considering big financial commitments like this.
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