While the large number of mortgage and loan types gives consumers a lot of choice, at the same time it intimidates first-time home buyers who find the task of choosing the right mortgage quite daunting. However, finding the right mortgage for yourself and and applying for it is not as complicated as it seems.
Some terms to understand
It is important to understand the concepts used by the financial system when you decide to apply for a mortgage.
Mortgage: A mortgage (Law French for "dead pledge") is a device used to create a lien on real estate by contract. It is used as a method by which individuals or businesses can buy residential or commercial property without paying the full value upfront. The borrower (also called the mortgagor) uses a mortgage to pledge real property to the lender (also called the mortgagee) as security against the debt (also called hypothecation) for the rest of the value of the property.
In simple words, a loan to purchase a home, where the property is used to guarantee repayment of the loan is called mortgage. It is a debt instrument to purchase a home by which a borrower (mortgagor) gives the lender (mortgagee) a collateral or lien on property as a guarantee for the repayment of a loan. Sometimes it is the terminology and jargon used what makes mortgages look like a complicated deal.
Creditors & Lenders: A creditor is the person or institution making a loan available for those wanting to purchase real estate. Creditors are also referred to as mortgagees or lenders. A creditor is a party (e.g. person, organization, company, or government) that claims that a second party owes the first party some property or service. The first party, in general, has provided some property or service to the second party under the assumption (usually enforced by contract) that the second party will return an equivalent property or service. The first party is frequently called a lender, and the second party is frequently called a debtor or borrower or mortgagors or obligors.
Type of Mortgage
Fixed Rate Mortgage: This is a mortgage for which the rate of interest is fixed for the term, ie, a set period of time. The monthly principal and interest payments remain the same throughout the life of the loan. The most common mortgage terms are 30 and 15 years. With a 30-year fixed rate mortgage your monthly payments are lower than they would be on a 15 year fixed rate, but the 15 year loan allows you to repay your loan twice as fast and save more than half the total interest costs.
The advantage of this type of mortgage is the fixed monthly payments and interest rates regardless of any fluctuation in the market, but equity building is slower because the first few years of payments are applied toward interest not principal.
Adjustable Rate Mortgages (ARM): An adjustable rate mortgage is considerably different from a fixed rate mortgage. ARMs have only been around since the early 1980s. They were created to provide affordable mortgage financing in a changing economic environment. An ARM is a mortgage where the interest rate changes at preset intervals, according to rising and falling interest rates and the economy in general. In most cases, the initial interest rate of an ARM is lower than a fixed rate mortgage. It has adjustable interest rates in short-length terms that depend on current market rates. The teaser rate, first year mortgage interest rate, is generally a couple of points below the current market rate. Because ARM rates can go up to a certain limit or cap, initial mortgage interest rates are lower, typically 1 or 2 points below current market rate, however interest rate could increase significantly during the adjustment period increasing the monthly payment.
Balloon Mortgage: A balloon mortgage is one in which monthly payments are made for a specified period of time, with the balance of the loan paid in full at the end of the loan term. Like an ARM, interest rates on a balloon mortgage are typically lower than on a fixed rate mortgage. Balloon Mortgage is a sort of short-term loan where the loan payment is amortized following the same model of a fixed-rate mortgage but for 5 to 7 years. At the end of the initial period, the mortgage's full balance is due in one single payment known as the balloon payment. Mortgage interest rate and payment of balloon mortgage are lower than conforming 30-year fixed rate mortgages, The only bad thing is that the entire mortgage balance comes due at the end of the term and if you do not have the funds to pay, you will need to refinance the mortgage with the possibility of higher interest rates.
FHA Mortgages: Is a home loan made through an approved lender and insured by the Federal Housing Administration (FHA). The down payment can be low as 3%, allowing 6% sellers concession in states where applicable. FHA Mortgages are available as 15-year fixed mortgage rate or 30-year fixed mortgage rate. Federal approval requirements are less stringent than conventional type mortgages, but interest rates and loan closing costs may be slightly higher than conventional loans.