What Is A Mortgage & How Does It Work?

Mortgages are loans that allow for homeowners and businesses to purchase property without having to pay for it all at once. The homeowner pays back the loan, with interest, over a set amount of time. When you take out a mortgage, the property is set up as collateral. This incentivizes homeowners to pay off the mortgage, otherwise the bank is subject to foreclose on your home. You retain ownership of your own home as long as you continue to pay off the loan at the agreed-upon rate. 

Getting Started

So, how does a mortgage work? The process begins when prospective homeowners apply to different lenders. You will need to present bank statements, tax returns, and show that you are currently employed as evidence that you are able to support payment on a new loan. Your mortgage lender will also likely check your credit.  

Once your new homeowner’s application is approved, your lender will negotiate a loan of a set amount with an interest rate. There is also a process called pre-approval, where you can get a mortgage lender’s approval whether or not you have a particular property to buy yet. Getting pre-approved for a mortgage provides an advantage for home buyers as well, since in a competitive market, sellers are more likely to consider a buyer’s offer that is already approved and backed by a mortgage company. 

Types of Mortgages

There are more options now than ever before when it comes to selecting a mortgage plan that works best for you and your financial needs, the most common being a fixed-rate mortgage.  

Fixed-rate Mortgage

This type of mortgage has a set interest rate that does not fluctuate over the entire duration of the loan. On top of a set interest rate, the monthly payments for this kind of mortgage remain fixed for as long as you have the mortgage, lasting anywhere from fifteen to thirty years. The only rates that are subject to change would be your property taxes and insurance for any given month. The appeal of the fixed-rate mortgage lies in its long-term stability. You know what you are getting into from the beginning, and what you will end up paying on a monthly basis for the entirety of the loan. Many homeowners who intend to live in one place for years and years find this the most rewarding option. But there are other homeowners who are unable to commit to a fixed rate, and are more interested in finding an option that provides the lowest interest rate. 

Adjustable-rate Mortgage (ARM)

The adjustable-rate mortgage has, like is sounds, changeable interest rate. It is dependent on the changing market conditions and typically is adjustable once a year. Having a changing interest rate on your mortgage payment makes it more challenging to determine the size of the payment for any given month, but the appeal of ARMs is in the lower initial rate, since those tend to be much cheaper than fixed-rate mortgages. 

Interest-Only Mortgage

For these types of loans, the prospective homeowner only has to worry about covering the interest on the mortgage for a set amount of time. You would pay the principal in installments, or all at once on a specific date. Usually, these interest-only mortgages are made up of only the interest payments for the first five to ten years. From there, the mortgage would convert to a normal payment schedule, and the homeowner’s payments would increase with factoring in the interest plus an amount of the principal. 

Reverse Mortgage

Despite the name, this type of mortgage still implies borrowing money against your property. So how does reverse mortgage work? The reverse mortgage works by paying you as long as you stay in your home. This is only an option if you already own a home outright or have significant equity built up, against which you can borrow.  

Typically, this type of mortgage is for homeowners in their 60s and older who need money, whether it be in the form of a credit line or checks. Homeowners who pursue this option understand that they will not sell or move homes, since the money they receive is really borrowing against the equity of their homes. One of the drawbacks to this type of mortgage is high closing costs, and on top of that you will still have to cover taxes and mortgage insurance. 

Breakdown of Mortgage Payments

What do mortgage payments consist of? What, specifically, does your money go to each month? Every time you make a mortgage payment, it is divided between four main groups: principal, interest, taxes, and insurance.

Principal is the amount of the balance on your mortgage that you pay off with each consecutive payment. 

Taxes are what you have to pay monthly toward your property. These are subject to vary each year whenever your property or neighborhood is assessed. 

Insurance is required by mortgage companies for emergencies such as fire, flood, theft, or any accidents that may occur in your home. Depending on your loan type, or if you paid less than 20 percent on your down payment, you may have additional fees for mortgage insurance. 

Pathway Homes understands how complex the home buying process can feel, and we are willing to come alongside our customers exploring their options for mortgage loans. We will do everything we can to assist you and help you through the process.