July 15, 2013

#Housing101: What is a mortgage?

My parents always tell me that the biggest purchase they made in their lives was buying our house. For a long time, I thought that my parents were simply talking about their utilities bills and maintenance fees, when they were actually talking about their mortgage.

I knew that a mortgage was one of the many fees related to owning a home, but I did not know exactly what the term meant. I thought I would figure out what a mortgage was when I went to buy my own home. The process of buying a home seemed to have no impact on the daily life of a college student, until I realized that my current financial actions will affect my credit score which in turn will greatly affect my ability to apply for a mortgage.

Simply put, a mortgage is a loan people take out to buy a home. The loan is given to potential property owners by financial institutions such as banks or credit unions. Home owners are legally required to repay their loan during the agreed-upon time frame, which ranges from fifteen to thirty years. If you fail to repay the lender for your loan, the financial institutions can repossess and sell your home to pay off the debt.

Each month, the homeowner pays a certain amount to the lender to repay the debt. This monthly fee is a compilation of different costs. These costs are commonly referred to as PITI, which stands for Principal, Interest, Taxes and Insurance.

The principal is the sum of money the homeowner borrowed to buy the home. Before this cost is calculated, the potential homebuyer gives the lender a sum of cash, called the down payment, to reduce the overall amount of the principal.

Interest is a percentage of the principal sum, which the lender charges the homeowner to use the amount of money borrowed. Some mortgages have fixed interest rates, which others have adjustable rates that change over the course of the loan. On top of the given percentage, the lender could also charge the homeowner additional loan costs known as points. Each point is one percent of the principal amount.  If one has an adjustable interest rate, they may prefer to pay points instead of paying for an interest rate that may rise over time.

While the principal and interest fees comprise the bulk of a homeowner’s monthly payment, a mortgage could also include money that’s deposited in an escrow or trust account to pay certain taxes and insurance.

The community where the home is located levies taxes based on the value of your home. These taxes are generally used to help finance the cost of running the community. Even if you have repaid the mortgage loan to the lender, you will continue to pay taxes.

Most lenders require that homeowners take out insurance against losses from fire, theft or other causes. These funds may be collected by the lender or held in escrow, meaning that they will not be used unless the obligations required are fulfilled.

The information above is a very basic sketch of what compromises a monthly mortgage cost. For more information about mortgages and the home buying process, please visit HUD’s home buying videos.

Shopping for your Home

Shopping for your Loan

Closing the Deal

Olivia Lapeyrolerie is a Summer Intern in HUD’s Office of Public Affairs.

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