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What are Mortgage Loans ?
A mortgage loan is a loan for
purchasing a house where the property bought is itself used to
guarantee repayment of the loan. In essence, you pledge your
home in return for money. You own the property, but the
creditors can take possession of the property or sell it if you
are not able to repay the loan.
A mortgage loan typically consists
of two parts
• The capital which is the amount of money you borrowed to buy
your property.
• The interest which is the amount the lender charges for
lending you the capital.
The most important thing about any mortgage is knowing how much
interest rate you have to pay. The lower the interest rate the
less you will have to repay.
In a typical mortgage scenario, the
main players are
Creditor is the issuer of
the mortgage loans. Typically, creditors are banks and other
financial institutions who issue the loans for purchase of real
estate. Creditors are also known as the mortgagee or lender.
Debtor is the one who takes
the loan. Typically the debtors will be the individual
home-owners, landlords or businesses who are purchasing the
property. A debtor is also known as the mortgagor, borrower, or
obligor.
Mortgage Broker acts as an
intermediary who secures mortgages on behalf of individuals or
businesses and also find prospective buyers for banks and
financial institutions.
Legal representation
Sometimes due to the complicated legal nature of the
transactions, a lawyer, solicitor or conveyancer may be needed.
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Types of
Mortgage Loans
There are various types of mortgage loans available in the
market but the two basic types of amortized loans are the fixed
rate mortgage (FRM) and adjustable rate mortgage (ARM)
Adjustable Rate Mortgages (ARM)
These are mortgages in which the interest rate is fixed for a
period of time after which it will periodically (annually or
monthly) adjust up or down depending on the market rate.
Interest rates are usually fixed for the first 1, 3, 5, 7 or 10
years. After the fixed period is over, rates will be allowed to
fluctuate within the limits of your contract with the lender.
These loans usually tend to have a lower rate initially and are
thus attractive to the borrowers. However, the borrower is
taking the risk that he can still afford the house after the
rates are free to rise, though you could renegotiate if rates
start to go back up.
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Fixed Rate
The interest rates are set and do not change for the term of the
mortgage. In the U.S., the term is usually for 10, 15, 20, or 30
years. This type of a mortgage is popular when rates are falling
and the borrower wants to lock in on the low price.
There are two ways to repay the
loans
Repayment and Interest Mortgage: This is the most popular method
where you will repay both the capital and the interest over a
set period of time (normally 25 years). For the first few years
of the mortgage you will be paying mostly the interest on the
loan and a small amount of capital. But as time goes on, you
will be repaying more capital and less interest depending on the
amount you pay each month. You will see the balance becoming
increasingly smaller over the term of the loan.
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Advantages of a repayment and interest mortgage
• It is possible to pay off lump sums of your mortgage to
minimize the balance and make the term shorter.
• You know the full balance of your mortgage and the term of the
repayment. This can help you plan your financial future.
Disadvantages of a repayment and
interest mortgage
• In the early stages of repaying your mortgage, the majority of
the monthly repayment is interest rather than capital.
• If payments are not regular and on time the house will be
sold.
Interest-only mortgage
As the name itself suggests, you will be paying only the
interest on your loan during the mortgage term. When the term
ends, you will still have to pay off the capital. When you take
an interest-only mortgage, you will need alternate savings plans
to build up the funds required to pay off your loan at the end
of the mortgage period. These alternate plans will grow along
with your mortgage to build up the balance of your loan. |
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There are
three main types of saving schemes
Endowment Policy: You pay cash
into an endowment policy throughout the mortgage period. This policy
can be obtained from an Insurance company or an independent
financial advisor (IFA).
ISA Mortgage: You invest in
stocks and shares via an Individual Savings Account (ISA) through
banks, building societies, or insurance companies. This account is
tax-free.
Pension mortgage: You will use
your personal pension fund (tax free) to pay off the debt. The money
paid into the pension will be invested on the borrower's behalf to
eventually pay back the debt. You can also have an interest-only
mortgage without a savings plan but you will have to prove you can
repay the debt with an inheritance or other means.
Advantages of an interest-only mortgage
• You could earn more than the required amount of cash through the
investments and savings which will leave you with more cash for your
own personal use.
• Some plans have good tax benefits and help reach the required
amount at a quicker and cheaper rate.
Disadvantages of an interest-only
mortgage
• Your investments may not fetch you the required amount of cash
which means that you could face a shortfall.
• Cashing in your endowment, ISA, or pension could have adverse
effects on the amount of money you have saved over the past. There
could be penalties for cashing in early.
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Article Contributed By: Jaya Suresh
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