A mortgage or a loan is a financial arrangement between the lender and borrower that usually entails a purchase of real estate. Such a loan is typically borrowed from a bank against a property in which the borrower resides. The borrower sets the real estate property as the collateral for the loan, meaning that the bank or the lender can take away the property if the borrower fails to make regular payments.
Here are a few terms you must keep in mind when entering into a mortgage as they define certain parameters such as repayment terms, what happens in case of default, and how the process unfolds in the real world and its repercussions.
Loan Agreement:
The mortgage process begins with the financial agreement, aka mortgage, which contains the governing terms and conditions on how the loan will materialize. The major points include the principal amount, monthly or other fixed interval payment schedule, etc. These terms and conditions represent a crucial understanding between the two parties as to how their relationship viz a viz the loan will take place over the following months. Understanding all the terms and conditions, the type of loan agreement, setting collateral, and the prevalent interest rates all play a significant role in determining your future commitments.
Type of Mortgages:
Before we delve into the definitions of essential terms governing mortgage agreements, it is crucial to consider the type of mortgage agreement you wish to enter into, as it will define when you will make repayments and at what rates.
Fixed-Rate Mortgage:
The important thing about a fixed mortgage is its predictability, which is ensured by the fixed interest accruing for the duration of the loan. The total amount of interest is divided equally among monthly payments, which remain the same throughout the agreement period. Fixed-rate mortgages tend to be long-term ones with a typical loan duration set at 15, 20, and even 30 years. The plus side of such a mortgage is the ability to budget your finances according to the loan.
Adjustable-Rate Mortgage (ARM):
The variable rate mortgages occur when mortgages are tied to an index or margins set by the lender. It is beneficial only if you want to pay lower interest rates initially but can afford higher payments later.
Reverse Mortgage:
The third type of mortgage is where the borrower or the homeowner receives payment from the bank by setting apart a portion or the entirety of their house as equity. All reverse mortgage plans are typically offered to senior citizens aged 62 or older, who can then supplement their retirement income with monthly payments.
Property as Collateral:
One of the distinguishing features of a mortgage is that the purchased property serves as collateral for the loan. The real estate property or the house the borrower lives in shall be possessed by the lender in case of non-payment. The lender can then legally take over the house under the foreclosure process. The lender can sell the property and use the sum to pay off the mortgage debt.
Down Payment:
Securing a mortgage has a certain upfront cost that is to be paid in addition to the monthly payments. This payment is called a down payment, typically a fixed percentage of the loan amount. It can range from anywhere between 15% to as high as 50%, depending on the terms and conditions of the agreement.
Interest Rate:
The interest rate on the mortgage loan is the cost of borrowing money, which determines the total amount of money to be borrowed. Higher interest rates mean the cost of borrowing is high, and the total amount to be repaid will be substantially higher than the actual loan amount.
Loan Term:
As discussed earlier, there are different types of mortgages with different loan duration. The loan term usually defines what interest accrues over the principal amount. For example, the higher the term, the higher the interest accrued on the loan. Longer loan terms ensure smaller monthly payments at the cost of increased repayment.
Monthly Payments:
Borrowers are required to make regular monthly payments for loan repayment in the set loan duration or term. The monthly payments cover a portion of the principal amount and the interest, while some may also include insurance costs and property taxes. Amortization of the loan decides how the principal and interest amounts are divided over monthly payments. Initially, the interest amount is higher and decreases over time, while the opposite is true for the principal amount.
Prepayment Options:
Some mortgage agreements allow borrowers to make extra payments or pay off the loan early without penalties. Others may have prepayment penalties or restrictions, so it’s essential to understand the terms of the specific mortgage.
Ownership and Equity:
While you are making mortgage payments, you are also building equity in the property. As you pay down the loan, your ownership stake in the property increases. After the mortgage is fully paid, you own the property outright.
It’s important to thoroughly understand the terms and conditions of a mortgage before entering into such an agreement, as it represents a significant financial commitment. Different types of mortgages, such as fixed-rate and adjustable-rate mortgages, are available, each with its own features and advantages. Borrowers should carefully consider their financial situation and goals when choosing a mortgage that suits their needs.
Licensed broker Logan Patel holds an MBA in Urban Economics from UCLA and has steered buyers and investors through market swings for a decade. He joined us in 2024 to demystify listings, financing, and neighborhood data with clear, chart-backed advice. When he isn’t scanning comps, Logan coaches youth basketball and scouts mid-century districts for hidden architectural gems on weekend walks.
