When thinking about purchasing a home you will, probably, also start considering a mortgage to help you cover the costs. Most people don’t have the upfront cash to pay for a home outright, and a mortgage can help you spread the cost out over a more manageable period, albeit with some interest. Even so, you shouldn’t assume all mortgages are made the same. Indeed, you may be able to access a more favorable deal depending on which loan type you apply for.
In this short FAQ we cover the 3 main services provided by the biggest mortrgage lenders: Purchase, Mortrage Refinancing and Home Equity.
A mortgage loan (also referred to simply as a “mortgage”) is a type of loan designed specifically to help individuals and families finance the purchase of a home they would not be able to afford otherwise. Mortgages are in many ways like other types of loans—they have monthly payments, they accrue interest, you can get in trouble for missing payments and defaulting—but they have some features that set them apart.
For one, mortgages can only be used to purchase a home or property, and you are borrowing against the value of that property when you’re approved. Additionally, mortgage terms in most cases tend to be longer than other types of loans. Should you default on your mortgage, your borrower has the right to take your property as collateral.
Additionally, mortgage terms, as mentioned above, are significantly longer than other types of debt. To wit, while many loans can be paid off within 10 years, and some even within a few months, most mortgages will have a minimum repayment term of 15 years (though there are options for less time) and can last for up to 30 years.
When you’re taking out a mortgage, there are also different types of loans you can look for that are designed with specific borrowers in mind. These are some of the most common varieties:
There are many other types of mortgages you can apply for depending on your situation and a few other factors. However, it’s important to remember that mortgages are long-term commitments, and require planning and forethought to make sure you can afford them without putting yourself in financial peril.
Even though mortgages are long-term commitments, you may sometimes sign up for terms that are great when you apply, but not so great once you’re in a better financial situation. For instance, you may significantly improve your credit over the first five to ten years of your mortgage, meaning that what was once the best available interest rate for you may now be too high. Similarly, you may be able to cut down on your repayment term with a higher income, so you may want to change both. You may not be able to change your original mortgage agreement, but you can still find better and more favorable terms by refinancing your loan.
When you refinance a mortgage, what you’re doing is taking out a loan that will cover your remaining mortgage, but that comes with better interest rates, different repayment terms, or other conditions. This allows you to improve your mortgage repayments and reduce the total sum you pay over the lifetime of your loan (due to lower interest while freeing up your finances somewhat at the same time. Some of the biggest benefits of refinancing your mortgage include:
It’s worth keeping in mind that while refinancing your mortgage comes with several benefits, there are a few aspects you should consider. For instance, you may have to pay your new lender origination, processing, and other fees to change your loan. Additionally, you may have to cover legal costs for documents, forms, filings, as well as submit to credit checks and appraisals that could lower your score or slightly reduce the value of your home if it wasn’t properly or recently valued.
There are three main types of refinancing:
When dealing with mortgages, one of the most important factors lenders will consider is your home equity. In simplest terms, your home’s equity is your property’s current market value minus any liens and outstanding loan balances attached to it. The value isn’t fixed and will change as you pay down your loan (the equity will increase) or get a second mortgage (the equity will decrease). It may also change if the overall value of your home increases due to neighborhood improvements, remodeling, and other factors.
When you take a mortgage to purchase your home, your lender has an interest in your property—they technically own it, although you can still possess it. Your home equity is the portion of your property that you fully own and possess. You can gain initial home equity in your property through a down payment (the larger your initial deposit, the more you’ll have in equity), or over the long term by steadily repaying your mortgage down. Your equity may also passively increase via property appreciation.
You can also use your home equity in some cases to get credit, such as using a home equity line of credit (HELOC). When you take out a second mortgage on your home, lenders will look at your current equity in determining the amount you can borrow. You can either request it in a lump sum, or as a HELOC, which gives you a credit pool to draw from periodically as required.
For example, let’s imagine that the value of your home is $100,000. If you initially paid a down payment of 25%, your home equity is $25,000 initially. Assuming your home’s value remains constant over the next five years, paying down another $10,000 of your mortgage principal with repayments would put your home equity at $35,000. If your home’s value did increase by $100,000, your home equity would suddenly jump up to $135,000, as the appreciation is not covered by the mortgage.
In addition to a second mortgage, you can also use your home’s equity to help in a few different ways. In some cases, you can apply that equity to purchase your new home, using the proceeds from the sale of your previous home to lower your mortgage. Additionally, you can use that equity to get a reverse mortgage, which lets you use it to get a loan that’s fully repaid by the time you retire, and is available to you immediately.