Virtually everyone who buys a home uses a mortgage to do it. While paying that mortgage off completely is a great goal, odds are good you’ll be living with that mortgage for a long time. Here are ten things you should know about your mortgage.
1. Deed of trust
What we call a mortgage is generally a combination of two or more documents, including a promissory note (the loan itself) and the deed of trust (the lender’s recorded interest in your home). The deed of trust is what allows the lender to take your home and evict you from the property if you don’t pay the promissory note according to its terms.
2. Mortgage term
Generally, mortgages are written for 30 years. Mortgage rates will generally be lower for loans with shorter maturities. Mortgages of 15 years are fairly common. Twenty year mortgages are not common, but some lenders offer them — generally at rates indistinguishable from 30-year loans. A few lenders offer 10-year loans that fully amortize. Of course, few people can afford to pay for their home in just 10 years.
3. Variable rate loans
Variable rate loans come in an almost infinite variety. They are extremely risky for most consumers because the future payments could rise dramatically — sometimes doubling the initial payment. The most appealing of these are those with 5- and 7-year fixed rate periods. These loans provide you with that 5- to 7-year period to build equity, increase your income or otherwise prepare for the risk of fluctuating payments. Still, these loans may be best suited to people who anticipate moving within the 5- to 7-year window.
4. Mostly interest
Your monthly payment generally covers interest with only a small amount of principal. Even with the low rates homeowners pay more interest than principal.
5. Payments are in arrears
When you make your mortgage payment on January 1st, you are paying the interest for December plus a small principal reduction.
6. No prepayment penalty
Under federal law, mortgage loans are generally prevented from featuring a prepayment penalty. In other words, you can pay off the loan without paying anything extra. This allows you to refinance the mortgage if rates decline, essentially giving consumers a variable loan option that works only in their favor.
7. Extra payments
If you make an occasional extra payment or pay a little extra on every payment, you should be sure to instruct your lender to apply those extra payments to principal reduction. The effect will be to reduce the total interest you are paying and to accelerate the ultimate satisfaction of the loan.
The costs to the consumer to originate a loan generally run in the range of 2 to 3 percent of the loan amount. This represents thousands of dollars. Few, if any, of these expenses are eliminated for a refinance.
9. Loan-to-value ratio
At the time you obtain your mortgage, the ratio of the loan to the value of the property will be a key constraint on your ability to qualify. The highest percentage of value widely available is 95 percent. In that case, you would need a 5 percent down payment.
Here’s the trick: if the property is deemed by the appraiser to be worth less than the contract purchase price you will be required to pay an additional amount. Two years after the purchase of the property, the appraisal will determine the value of the home without regard to your purchase price — which is great news if the value has risen.
10. Late payments
Making late payments creates a variety of problems. Late payments are typically subject to a 5 percent late fee. Late payments may also be reported to credit bureaus, increasing your borrowing costs elsewhere. Once you get behind it is often difficult to catch up. Lenders will generally not allow you to catch up if you get more than 90 days behind. It may take several months after 90 days for the bank to take the house, but nothing short of paying the bank in full after 90 days may allow you to keep your home.
It is helpful to understand the language of the mortgage world. It will help make a gruelling process so much easier.
Devin Thorpe, husband, father, author of Your Mark On The World and a popular guest speaker, is a Forbes Contributor. Building on a twenty-five year career in finance and entrepreneurship that included $500 million in completed transactions, he now champions social good full time, seeking to help others succeed in their efforts to make the world a better place.