Understanding the Mortgage Structure

Understanding the Mortgage Structure

A mortgage is a debt facility, which the borrower has the obligation to pay within predetermined sets of payments secured by the collateral of a specific real estate property. Mortgages help individuals and businesses to make large real estate purchases paying for the property over a period of years. The borrower repays the principal amount plus interest, to the lender, and the home and the land around it serve as collateral. The lender has a claim on the property should the borrower default on paying the mortgage. The lender may foreclose on the property, evicting the borrower or their tenants and sell the property, then use the income from the sale to clear the mortgage debt.

Mortgage Payments

The size and term of the loan will determine the amount of mortgage payment repaid on a monthly basis. Size refers to the amount of money borrowed whereas term refers to the length of time within which the borrower should repay fully the mortgage. Longer terms result in smaller monthly payments resulting in an inverse relationship between the size and term of the borrowed amount. For this reason, 30-year mortgages are the most popular mortgage type because they give an affordable monthly repayment amount.

Components of a Mortgage Payment

When calculating the repayment structure and amount, it is prudent to consider the principal, interest, taxes and insurance (PITI). The principal is a portion of each mortgage payment specific to the amount borrowed. Normally the amount of principal returned to the lender is low during the beginning of the repayment period, and increases with each payment. Interest is the lender’s reward for taking a risk to provide the money to a borrower. The interest rate directly influences the size of a payment. The higher the interest rates the higher mortgage payments.

Taxes are the payments to the governmental agencies and who in turn use them to fund various public services such as school construction. The government determines the tax amount payable per year, which can be paid monthly, or annually by the borrower. Insurance payments make part of each payment and are in escrow until the bill is due. Mortgages charge property insurance, which protects the home and its contents from disasters such as fire, theft. Mortgages also charge a PMI, which is mandatory for mortgages at a down payment of less than 20% of the property’s cost. It is to protect the lender in the event the borrower is unable to repay the loan.

Understanding types of mortgages

Mortgages are available in two main forms. These include the fixed-rate mortgage where the borrower pays the same interest rate for the life of the principal amount borrowed. The monthly principal and interest payment do not change with fluctuations in the financial market and you do the repayments within a 15 or 30-year term. The adjustable-rate mortgage, where the interest rate is fixed for an initial term, but after a given time, it fluctuates with market interest rates as described at dollarcents.org


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