A mortgage is a financing option available to residential or commercial loan applicants. It allows them to put their real estate property as collateral with the bank, and in return get excess to some extra cash based on the market value of the property. There are different types of mortgage loans available in the market today. Each of these facilities has its own terms and mortgage rates. The leverage that banks get when disbursing a mortgage loan is that it can safeguard its interest by keeping the applicant’s property as collateral until they pay off the loan.
The loan tenure of a mortgage can go up to 20 years. For this very reason, banks and other financial institutions offer different types of mortgage financing. These facilities may offer fixed or variable mortgage rates to applicants. Mortgage loans are not as simple as a personal loan or a credit card. They require a considerable amount of paperwork due to the technicalities involved while disbursing this type of loan facility. Mortgages rates are usually lower than credit cards or auto loans primarily because home loans are secured against a collateral.
Different Types of Mortgage Loans
Conventional home loans are primarily offered by non-governmental financial institutions. The loan amount is mostly based on an applicant’s creditworthiness, their debt to income ratio, and the value of the property. A conventional mortgage requires the collateral or the real estate property to be financially evaluated by an independent contractor before a mortgage loan be disbursed to a borrower. Once the fair value of the property has been evaluated, lenders may offer up to 90% of the property value as a mortgage loan to their borrower.
Since conventional loans are secured against the home owner’s property, lenders require applicants to insure their property before the loan can be disbursed. This allows banks to protect their collateral in case of any natural disaster or any other unfortunate event. Home insurance eventual increase the overall mortgage rates for borrowers.
This type of mortgage was offered during the great depression in the 1930s. Since the general population did not have enough finances to prove their creditworthiness, banks would only offer home loans to individuals who could prove that they could pay off the loans in the near future. Besides that, the Loan to Security ratio was dropped to nearly 50%. Mortgage rates during this period skyrocketed as well. As a result, half of the United States was renting rather than owning a real state property.
The resolve this issue, the government of the United States introduced FHA or Federal Housing Administration Loans. Under these mortgage contracts, the loan was secured by the government and financed by the banks. In case a borrower would default, the government would step in and pay off the rest of the mortgage to the lender. This allowed banks and other financial institutions to soften their loan requirements allowing more people to apply for a mortgage loan.
Today, any low to medium wage earner can apply for an FHA loan by making a minimal or zero down payment to the bank.
VA Mortgage Loan
This home loan scheme has been organized by the department of veteran affairs to allow qualified war veterans and their spouses to apply for a home loan facility. VA mortgage loans are insured by the Department of Veteran Affairs and allow borrowers to avail mortgage loan up to 100% of their property value. The eligible veterans can use this mortgage facility to buy, renovate or rebuild their real estate property. In case a borrower defaults on a VA loan, the Department of Veteran Affairs guarantees to repay a portion of the loan back to the lender. For this very reason, mortgage rates on VA loans are not high as well.
There are primarily two ways in which interest rates can be applied on a mortgage loan. These include:
Fixed Rate – In such type of repayment plan, the borrower pays a fixed interest amount every month till the repayment schedule ends. Since the mortgage rates are fixed, there is a considerable amount of predictability in these types of loans. However, fixed mortgage rates do not allow the borrower to enjoy the downside of the interest rate market. What this essentially means is that even if the interest rates go down, the borrower will have to pay the same rate they were always paying.
Adjustable Rate – With adjustable mortgage rates, interest payment remains the same for the initial few months and then starts fluctuation as there is a change in the market. The benefit of adjustable mortgage rates is that the monthly repayments are reduced as interest rates go down. However, if the market experiences an upside, the borrower will have to make higher payments.
Home Equity Loan
Another variation of a mortgage loan which is relatively new compared to conventional loans is known as a home equity or a second mortgage loan. In this type of mortgage, a homeowner can use their home equity to avail financing from a bank. If a mortgage borrower was given a $70,000 loan on a $100,000 property 5 years ago, and the property value has doubled over time, they can take up an extra mortgage based on the additional equity in their home.
The cash received from the home equity loan can be used for many different purposes including debt consolidation, investing in a new business, or renovating the existing property. Interest expense on a Home Equity Loan that is used for renovating the property is considered as tax deductible by the federal government.
Mortgage financing is a great way to invest your monthly income in real estate. However, when applying for a mortgage loan, you should ensure that your debt burden is not too high, and your credit history does not show any delinquencies. Mortgage loans are not a high-risk loan, but the tenure is quite long and to protect their interest over a long period of time, lenders perform thorough due diligence before disbursing this loan.