Understanding mortgages

A long-term loan for property, and the buildings on the property, is called a mortgage. Lending institutions such as banks and mortgage companies are the largest mortgage lenders, but some credit unions offer long-term loans. Sometimes a seller will finance the home they are selling and some mortgages are assumable from the current homeowner.

Paying back the capital

Most mortgages generally require down payments as a firm commitment from the buyer to the lender of the buyer's intention to repay the loan. Some lenders will offer mortgages for 97% or 95% of the value of the property. The borrower, then, is required to make only a 3% or 5% down payment. Generally, when a mortgage is made with less than a 20% down payment, mortgage insurance is required.

Paying back the loan, you can either pay a little at a time as you go or pay it all off at the end which are explained as follows:

Repayment mortgages - Each monthly payment pays off a little of the underlying debt, as well as interest on the loan. At the end of the term the mortgage is cleared.

Interest only mortgages - With this type of mortgage, you pay-off the interest on the loan but not the capital. At the end of the mortgage term you are expected to repay the capital, how you fund this is your business.

Endowment Mortgages - You use an endowment policy to provide life insurance and save funds to repay the loan at the end of the term (usually 20-25 years). In the 1980s endowments were very popular and heavily marketed by lenders. However, many people were not told of the investment risk. This was mis-selling and lenders faced huge claims for compensation. As a result, endowment mortgages have declined sharply in popularity. Relatively few endowments are sold today but there are still millions of policies yet to mature.

Paying the interest

As in cases of other debts, you have to pay interest on mortgages. Howerver, there are range of options to pay the interest.

Variable rates - This means you pay the going rate on your loan. The mortgage rate changes every time interest rates change or, as in most cases, the overall effect of any interest rate changes is calculated once a year and payments are altered accordingly. Whatever kind of mortgage you start with, it is likely to change to variable rates at some point.

Fixed rates - The interest rate is fixed for the period agreed - often two to five years. These are ideal for budgeting or if you think rates might increase. You do not benefit if rates fall, and will face penalties if you try to quit.

Be aware of very low rates as they can be used to trap you into paying over the odds at a future date. So one has to check how long you will have to stay with the lender before you can switch without penalty.

Capped rates - These are fixed, but if rates fall you pay the lower rate. Such deals can be a good for budgeting.

Cash back deals - This is when lenders offer money back if you take out a particular product. However, nothing comes free in life and cashback mortgages may be weighed down with hefty penalty charges if you later want to switch lender.

Discounted rates - Under this type of mortgage the borrower is offered a discount off the lender's variable rate. The rate paid will fluctuate in line with changes in the variable rate. The discount applies over a set term.

Bad Credits

Lenders divide customers into two classes namely good and bad. The good credit holders get low rates and friendly terms. The bad credit holders get high fees and ugly rates. Bad credit mortgages, or subprime loans, were created for borrowers with varying problems, such as a bad credit score, insufficient credit or employment history, nontraditional credit, unverifiable income, or inadequate savings. Lumping them all into the same category forced some borrowers to pay higher rates than they deserved. Today, however, borrowers with a just a few credit dings can find better terms for their bad credit mortgage or debt consolidation loan. Understanding bad credit mortgages pricing can save you a lot of money.