What Is a Mortgage?
A mortgage is a loan that’s used to buy real estate, such as a house. The property being bought serves as collateral for the loan, meaning that if the borrower fails to make payments on time, the lender can seize the home in a process called foreclosure. Mortgages are typically secured by a deed, a legal document that gives the lender a lien on the property. The document also contains a promise to repay the loan and a set of terms that the borrower must follow.
There are many types of mortgages available worldwide, subject to local regulations and laws. However, there are some basic characteristics common to most mortgages:
Borrowers must provide documentation of their financial qualifications, including income and employment history. A credit check is usually run as well. A homebuyer’s ability to afford a mortgage is determined by taking into account debt-to-income ratios, loan-to-value ratios and credit score ranges. Lenders also generally establish a maximum term for the mortgage, which is the amount of time before it must be fully repaid, and an interest rate that’s either fixed or variable.
Most people buying a home can’t pay the full price of the home upfront in cash, so they take out a mortgage to cover the purchase. Monthly mortgage payments help the borrower build equity in their home, and the principal amount owed decreases over time as more of each payment goes toward the borrowed capital. Mortgages are commonly amortized over 30 years, although shorter or longer terms can be obtained.
A person may choose to get a mortgage for more than one home, such as a primary residence and a vacation or investment property. Different mortgage guidelines apply to each occupancy, with more stringent requirements for second homes and higher rates and down payment requirements for investment properties.
Mortgage loans are not guaranteed by the government, and most mortgages have a private investor as the lender. The private investor is a key source of mortgage funds, and they are often willing to offer lower rates and other benefits to attract borrowers. Some lenders use an automated underwriting system to approve mortgages, which helps streamline the process and reduce the risk of default.
If a borrower is unable to make payments on time, the lender has several options. Often, the lender will try to work with the borrower to find a solution before resorting to foreclosure. Lenders may also sell mortgage loans to other investors, who in turn fund the borrower’s payment stream with interest income.
Before applying for a mortgage, a person might decide to consult with a mortgage broker, who can help them compare offers from multiple lenders. Mortgage brokers are paid a fee, typically expressed as “points,” that’s added to the cost of the loan or collected at closing. This can be an expensive option, and borrowers should carefully review their options and shop around to ensure they’re getting the best deal. It’s also possible to obtain a prequalification, which is less formal and might not require any of the lender’s verifications or credit checks.