The modern mortgage market provides homebuyers with a variety of mortgage loans, which can be confusing due to their different titles and details. However, understanding the basic principles that govern all mortgage loans can make it easier to make sense of these loan types. In this article, we will discuss these principles and loan types to help you make an informed decision.
Basic Principles of All Mortgage Loans
- The home serves as security for the loan and can be sold by the lender if the borrower defaults on payments.
- The larger the loan compared to the home’s value, the riskier it is for the lender, and typically, the more expensive the loan will be.
- The interest earned by the lender is always equal to the periodic interest rate multiplied by the outstanding principal balance of the loan. The periodic interest rate is the annual interest rate divided by the number of payments in a year (usually one per month).
- The required payment is usually slightly larger than the interest due to ensuring that some of the loan principal is repaid with each payment. This process is known as amortization, and most mortgage loans can be retired when all the monthly payments have been made.
Types of Mortgage Loans:
All mortgage loans fall under one of the following categories:
- Fixed payment and fixed interest rate – fixed-rate mortgages.
- Fixed rate but variable payment – graduated payment mortgages.
- Variable rate and variable payment – adjustable-rate mortgages.
Comparison of Loan Types
When comparing different loan types, you may notice that some loans have more favorable terms than others. However, this may indicate that those loans could have some feature that is less appealing to borrowers. For example, shorter-term loans often have slightly lower interest rates compared to longer-term loans. Still, the monthly payment for the same amount of principal may be higher due to the shorter term. Variable-rate loans usually have much lower interest rates to compensate for the risk that the borrower accepts that interest rates may rise in the future.
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