Financial Dictionary -> Mortgages

Owning a home has been a life goal for many people - a home where your kids will grow up and a home full of pleasant memories. Unfortunately most people don't have the cash to buy a home right away, and their only option is to get a mortgage. A home purchase is usually the bigger purchase in one's life, so being familiar with various mortgage terms might be very important for your financial future.

There are several basic mortgage terms you should be familiar with, before even thinking of purchasing a real property and getting a mortgage. These terms include down payment, amortization, mortgage principal, and mortgage term to name a few. People who plan to invest in real estate might be interested in learning more about real estate investment trusts (REIT).

Types of Mortgages

Understanding how different mortgages work is crucial if you want to avoid a foreclosure down the road. There are many different types of mortgages like adjustable rate mortgage also known as ARM (very unpopular with the ongoing financial crisis and the deflation of the housing bubble), fixed-rate mortgage, conventional mortgage, assumable mortgage, HELOC (Home Equity Line of Credit), first mortgage, and second mortgage.

Mortgages are offered by different financial institutions, including credit unions and brick-and-mortar banks. In addition to the above varieties, there are other types such as high ratio, low ratio, closed and open, pre-approved, equity, and first mortgages. Bridge financing is also offered as a type of short-term loan with a rate of 2 – 3 percent higher than the bank’s prime rate. The open mortgage is another variety and a type of a short-term loan.

The closed mortgage is a long-term solution with a term of up to 10 years. Prepayment is often an option up to 20 percent of the principal amount. Customers who plan to pay the full amount before maturity face early prepayment penalties. It is usually equal to three months of interest. With fixed rate mortgages, the interest charges remain fixed over the loan term so that the interest and principal payments also remain the same on a monthly basis. This is a popular choice among homebuyers because it makes budgeting and planning much easier. It is also a good solution when the mortgage rates are low. With adjustable rate mortgages, customers benefit from a greater degree of flexibility. While the principal payments remain the same over the loan term, the ratio between the interest charges and principal fluctuates. Falling interest rates are to the advantage of borrowers because they pay more toward the principal and less in interest charges. When rates are going up, customers pay less toward the principal. However, if the rates increase substantially, the payment may not be sufficient to cover the principal amount and interest payment. The problem is that borrowers still owe the amount not paid. In this case, the financial institution may increase the amount of the monthly payment. On the positive side, this type of mortgage is convertible meaning that customers may choose to convert to a closed term, and there are no prepayment penalties.

Other types of mortgages include discount, offset, and tracker mortgages. They have both pros and cos. Discount mortgages, for example, are different in that financial institutions are free to change the standard variable rate. This can occur even if no changes to the base rate have been made. Offset mortgages link mortgage debt to the borrower’s savings. One problem is that this is a complicated type of loan. Another is that the interest charges are higher. On the good side, borrowers enjoy tax savings. We also have equity mortgages that are based on the assessment of the applicant’s home equity. They are usually available to borrowers who are unable to meet the credit rating and income requirements. In addition to different mortgage loans, financial institutions also offer secured lines of credit whereby borrowers use their home equity to finance the purchase of a vehicle, make home renovations, or purchase investment instruments. With lines of credit, customers pay appraisal and legal fees that increase the cost of borrowing. This is a versatile and flexible product but some borrowers are tempted to overspend and end up with huge amounts of debt.

Commercial Mortgages, Types and Terms

Businesses are also offered mortgage loans of different varieties, including second, interest-only, fixed rate, and adjustable rate mortgages. The main benefit of commercial ARMs is that businesses are offered more funding. Fixed rate mortgages go with long repayment terms of 20 years or more. Financial institutions also offer interest-only loans whereby borrowers make small interest-only payments. Payments are made for a period of 5 – 10 years before settlement. At the end of the term borrowers make a large lump sum payment. These loans are usually offered to start-ups that require little capital. Second mortgages are also available to businesses that need urgent cash and usually have a term of 20 years. Customers can choose between interest-only or fixed-rate loans. In general, financial institutions offer both floating and fixed rate options and require collateral in the form of commercial property. Different financial establishments offer commercial loans, including mortgage brokers, insurers, government agencies, conduit lenders, and banks. The loan amount varies based on factors such as the service coverage and loan to value ratio. Other factors banks look into are the cost, rents, and replacement cost per sq. foot. The rent operating income is also factored in. Financial institutions also charge fees such as exit, underwriting, and application fees. Appraisal may be required. The term varies depending on the type of loan and can range from 1 to 10 years. Commercial loans usually have terms of 5 to 10 years. Some financial institutions offer prepayment options while others charge early prepayment penalties.

Learn what a mortgage broker is, and how you can use one when shopping for a mortgage. You can also learn about lawyers specializing in real estate transactions. Find out what deed and closing are, and learn more about mortgage insurance.