Mortgage

A mortgage enables an individual to finance the acquisition of a residence or other real estate. Typically, one secures a mortgage from a financial institution such as a bank, credit union, mortgage company, or savings and loan association. Given that mortgage loans involve substantial sums of money, lenders necessitate some form of collateral for these loans. Collateral refers to an asset of value that the lender can seize in the event that a borrower defaults on (fails to repay) their loan.

The property being purchased with the mortgage holds intrinsic value and is usually pledged as collateral for the loan. Most mortgage agreements stipulate that the borrower must repay the loan in monthly installments, commonly over a duration of 15 or 30 years. These payments are divided into principal and interest.

Principal and Interest

The principal represents the total amount of money you borrowed to acquire your home. To reduce your principal amount upfront, you may provide a percentage of the home’s purchase price as a down payment. Typically, lenders require a down payment equivalent to 20 percent of the home’s purchase price to qualify for a mortgage. Interest is the fee charged by the lender for the privilege of using the borrowed funds, usually expressed as a percentage known as the interest rate. In addition to the interest rate, the lender may also impose points and additional loan-related costs. Each point corresponds to one percent of the financed amount and is incorporated into the principal. Principal and interest constitute the majority of your monthly payments in a process known as amortization, which systematically diminishes your debt over a specified period. During the early years of amortization, your monthly payments predominantly address the interest, gradually shifting to reduce the principal in subsequent years.

Collateral

By entering into a mortgage agreement, you are executing a legal contract in which you commit to repaying the loan along with interest and other associated costs. Your home serves as collateral for that loan. Should you fail to fulfill your repayment obligations, the lender possesses the right to reclaim the property and liquidate it to satisfy the debt, a process referred to as foreclosure. In the event of foreclosure, you will forfeit your home and likely experience a detrimental impact on your credit rating, which could hinder your ability to purchase a new property in the future.

Taxes

In addition to your principal and interest, your mortgage payment will likely encompass property taxes. These taxes are levied by your municipality based on a percentage of your home’s assessed value. Such taxes typically fund the operational costs of your community, including the construction and maintenance of schools, roads, and other infrastructure, as well as the provision of various public services. Generally, if your down payment is less than 20 percent, your lender perceives your loan as riskier than those with larger down payments. To mitigate this risk, the lender establishes an escrow account to accumulate these additional expenses, which are integrated into your monthly mortgage payment. Even in the absence of an escrow account, you will likely be responsible for paying property taxes for as long as you reside in your home.

Insurance

Lenders will not permit you to finalize the purchase of your home without obtaining homeowners insurance, which safeguards your residence and personal belongings against losses due to fire, theft, adverse weather, and other unforeseen events. If your home is situated in a federally designated high flood-risk zone within a floodplain and you are securing a federally insured loan, federal law mandates the acquisition of flood insurance. Should you opt for a conventional loan and provide a down payment of less than 20 percent of your home’s total value at closing, your lender will likely require you to pay for private mortgage insurance (PMI). PMI protects the lender against the risk of default on the mortgage. You will be obligated to make PMI payments for two years or until your mortgage balance decreases to 78 percent of the home’s original purchase price. If you select a loan backed by the Federal Housing Administration (FHA), you will be required to pay mortgage insurance. This insurance functions similarly to PMI; however, the duration of these payments will be for 11 years or for the entire lifespan of the loan, contingent upon your loan terms and down payment amount.