Homeownership 101: What is a Mortgage?
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By Amanda Abella
June 13th, 2018
Have you found yourself inspired by the idea of owning a home in our Island state? The answer for most people is yes! But we also know that becoming a first-time homeowner in Hawaii is no easy task. That's why it's crucial to understand the process to make that dream a reality.
First, it's important to know what a mortgage is and which type is right for you. Here's the basics:
What is a Mortgage?
A mortgage is a legal agreement between a bank or mortgage lender and borrower to finance the purchase of a home or property. The lender holds the mortgage (a legal interest in the home) until the loan has been repaid. This is called a Mortgage Loan or commonly just referred to as a mortgage. Typically, you pay off the loan over a long period of time—generally 15-to-30 years, depending on your mortgage plan—by making monthly payments.
The Down Payment
In order to obtain a mortgage, lenders generally require you to pay a portion of the loan upfront, called a down payment. A rule of thumb is to save enough for a down payment that is 20 percent of the value of the property, but you may be able to put down less depending on the type of loan you decide to get and qualify for.
The Mortgage Payment
The mortgage payment you make each month is comprised of a few different elements:
- Principal: The principal is the total amount you borrow to buy a home. Let's say the home value is $300,000 and you put down 20 percent ($60,000). This means you borrow $240,000. Therefore, the principal on the mortgage would be $240,000.
- Interest: Interest is the price you pay to borrow the money from the lender, which is calculated as a percentage of the principal. Interest on mortgages can vary depending on market fluctuations, the property, the lender and your credit worthiness (ability to pay back the loan), among other things.
- Taxes: In addition to the principal and interest, you're required to pay property taxes. Most lenders prefer that you add property taxes to your monthly mortgage payment.
- Insurance: There are two types of mortgage-related insurance you need to know. The first is homeowner's insurance which covers your house and the property inside in the event of damage. The second is private mortgage insurance, which protects the lender in case you are not able to pay back your loan. Private mortgage insurance is required only if your down payment is less than 20 percent.
Types of Mortgage Loans
There are two main types of mortgage loans: fixed-rate and variable-rate.
With a fixed-rate mortgage loan, the interest rate remains the same for the life of the loan. This is may be a good option if you plan to stay in the home for a long period of time.
With a variable-rate mortgage loan, the interest rate is generally lower than a fixed-rate mortgage loan for a set amount of time (usually 5-10 years), then fluctuates for the remaining life of the loan. This is may be a better option you do not plan to stay in the home for very long.
The term of a mortgage loan is the time-frame over which you are allowed to repay the loan. This is also the time-frame used to calculate the interest you owe on the loan.
Terms can vary, but the most common are 15- and 30-year mortgage loans. If the interest and principal are the same, a 15-year mortgage loan will have a higher monthly payment, but you will pay less total interest than you would under a 30-year mortgage loan. Additionally, there may be lower interest rates available on a 15-year mortgage loan.
Obtaining a mortgage loan is a process taken one step at a time. For the smoothest process, be comfortable with asking your loan officer any questions that come up along the way.
Amanda Abella is a writer and Amazon bestselling author of Make Money Your Honey. She specializes in millennials, personal finance, credit cards, debt, student loans, budgets, investing and business.
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