Interest and Loans: Mortgage Basics
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Mortgage is a form of debt commonly associated with real estate property. It obliges the borrower to comply with a set of pre-calculated payments instead of requiring him/her to pay the whole bulk of a purchased amount upfront. The lending party (mortgagee/lender) has the right to claim the property should the borrowing party (mortgagor, borrower, obligor) fail to pay the mortgage. Aside from these two parties, other people that might be involved in such an endeavor include: a mortgage broker (someone who matches both a borrower and a lender), a financial adviser (one who provides financial insight especially on financial planning, borrowing, investing, and budgeting), and a lawyer (one who can legally transfer property from one party to another, may also be called a conveyancer).
Types of Mortgage Payments
Amortization or Repayment Mortgage
Capital and interest mortgage is the most common type of mortgage payment. Several repayments (or amortization), usually done monthly over several years (more than 10 years), consist of payment for the capital part and the interest part. The percentage of each part in each payment may vary over time. One is assured that the debt will be cleared at a definite future date.
Interest-only Mortgage
As the name says, interest-only mortgage requires monthly payments that pay only for the interest element of the debt. Of course, since one is only paying for the interest, the principal balance will not be paid with that set of repayments. Payments for the interest run for about five to ten years. After that, a different payment scheme can be used.
No Capital or Interest
Another type of mortgage payment available particularly to retiring borrowers is one where no payments are made. Called reverse mortgage or lifetime mortgage, such type of debt is not paid until the debtor passes away or is no longer living at the mortgaged house.
Partial Amortization
For interest and partial capital, or balloon loan, mortgage is determined given a certain period and installments are paid; the remaining balance from the capital must be paid before the end of the term. Bullet loans, as they are also called, are particularly useful when one plans to refinance or when one expects a large incoming sum.
Fixed Rate versus Adjustable Rate Mortgages
For fixed rate mortgages, interest rates are pegged throughout the term of the mortgage. As a result, the scheduled payments for interest and principal will be regular in amount. The opposite of this is the adjustable rate mortgage, in which the interest rate is initially set at a fixed rate, but will adjust according to a specified market index, such as the Prime Rate, the LIBOR, or the Treasury Index.
From their definitions, the advantages and disadvantages of FRMs and ARMs can easily be deduced, similar to that of fixed versus variable interest. FRMs guarantee how much you have to pay for the length of the mortgage, but that also means you might be paying more compared to ARMs if and when interest rates dip. ARMs are particularly risky because of the uncertain interest rate behavior, but it is also because of this you get a shot at saving more and you get initially lower interest rate offers from lenders.
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