Mortgages For Dummies!
Summary: This page offers some overview information about borrowing money to buy a house. It is our 'Mortgages For Dummies' guide!
Most people do not have enough money to buy a house outright, so they put a small deposit down, borrow the money from a mortgage lender and make payments on the loan each month.
The mortgage lender will then hold the deed to the property as security and allow the person taking out the mortgage to live in the property as if it were their own home while the mortgage is being repaid.
Payments will be expected monthly. These will cover either the interest only, meaning that the outstanding balance will never be repaid, or the interest plus a portion of the capital.
Interest Only Mortgages will have a set repayment date at the outset. This would normally be at either 20, 25 or 30 years depending upon a number of factors. A borrower will then make monthly payments to cover the interest charge.
However, the borrower needs to be making payments at the same time into some form of repayment vehicle. This might be an endowment policy (previously very popular in a number of countries - partly due to the high commissions earned for selling them - but now much more out of favour), a pension plan or some form of unit linked investment plan (perhaps a mutual fund or unit trust type of scheme).
The borrower takes on investment risks with this approach. If at the end of the mortgage term the investment has not grown sufficiently to repay the mortgage, the borrower will need to find extra money to redeem the loan and finally own the property.
Repayment Mortgages remove this investment risk by increasing the monthly payment to the lender. The lender will add an extra amount to each payment that is used to slowly lower the amount of capital owed.
In the early years, this amount of capital repayment is actually very small each month. As time passes and more of the loan has been repaid, the percentage that makes up the repayment element of the monthly payment increases and the balance will reduce more quickly.
Smart borrowers will use small amounts of money each month to make overpayments in the early years. These payments reduce the outstanding balance more quickly and therefore reduce the total cost of the mortgage (the amount paid over the full term) substantially.
Life Assurance will normally be required (legally) to ensure that should the borrower pass away before the full term of the morgtage is complete, the loan will be repaid and a debt will not be passed on to the borrowers next of kin.
Interest Rates vary between lenders and borrowers, meaning that there is often a wide range of deals available.
Your author holds professional qualifications in the UK mortgage market. These come from a period (2000-2003) when I worked in the UK market as a financial adviser. At the time I started in this profession, there were around 4,000 mortgage deals on the market at one time. By the time I moved on in late 2003, there were routinely 6,000 or more deals from UK lenders.
After the impact of the sub-prime crisis in 2007/8 in the United States, mortgage funding became much 'tighter' and far fewer deals were available (including of course, far less lenders, as many had shut because of their own funding problems). I am told that for a time in 2008/9, the UK mortgage market had shrunk to under 1,000 deals.
These deals might take the form of a fixed rate (the interest rate is fixed for a preset period of time, which is great if you have a fixed monthly budget) or a variable rate (where the interest rate is moves up and down in line with the national interest rates which are in turn followed by the lenders own base rate).
There are other deals such as discounts, balloons and capped rates in many markets. These will be explained to you if appropriate by any professional that you deal with when buying a property with a mortgage.
Deposits or down payments of between 5% and as much as 30% of the total purchase price may be required by the lender. In some countries
of between 100% and 110% are sometimes available. These rely on the funding and risk positions of the banks in question. A good (often theoretical) guideline when calculating the affordability of a mortgage is that the repayments should not equal more than 28% of your total income.
Mortgages are always secured by the property itself, therefore should you fail to meet the repayment you can lose your home. The lender will take a legal charge on the home which provides legal security in case of default. In many countries it is possible add extra lending with other companies in the form of a second or third charge. These are usually charged at much higher interest rates than a first charge because of the extra risk that they carry for the lender.
Investment using a mortgage is of course possible. After the global financial debacle of 2007/8/9, most people would need to have been living under a rock to not know what a 'buy-to-let' type of mortgage is.
Essentially, it is possible to borrow money to invest in a second or third property which is then let to tennants. In good times, this has the potential to generate a monthly income and capital gains - it is the perfect thing! However, in bad times, all that extra borrowing (which is likely rising in cost), combined with falling capital values and less money from tennants, makes this leverage highly risky to one's finances.
While many people make good money as an active landlord, be aware that there are very real risks in taking on the mortgage and responsibility for another property. Most people underestimate or fail to recognise them at all.
Warning: As noted above, the mortgage market can be very complex. Deals and costs can vary greatly in price. It is always best to seek out and follow personalised professional advice for your own situation.
Please follow these links to read more about debts:
Is Debt Repayment A Good Use Of Spare Money?
What Are Home Equity Loans?
Understanding Some Credit Card Basics
What Is Debt Consolidation?
Student Loans Consolidation