Mortgage Loan

A mortgage loan is a type of loan used to purchase a piece of real estate, typically a home but potentially an investment property or an undeveloped piece of land. Such loans are offered by numerous financial institutions, including banks, credit unions, and lenders specializing in mortgages. Some individuals hoping to obtain a mortgage loan choose to work with a broker, an experienced professional who helps identify the lenders offering the most favorable loan terms and assists the prospective borrower in applying for a loan. Applying for a mortgage can be a complex process and requires borrowers to provide a large amount of information related to their personal finances and employment status, as lenders in the United States are legally required to ensure that borrowers can afford their monthly mortgage payments. The borrower’s creditworthiness can have a significant effect on the interest rate and payment terms for which he or she qualifies.

Background

Although long in use by individuals hoping to purchase real estate but lacking the cash to do so outright, mortgages have evolved significantly over the decades. In the early twentieth century, most mortgage loans in the United States had very short payment terms by modern standards. Refinancing, the practice of obtaining a new mortgage for the same property in the hope of lowering one’s monthly payments or interest rate, was very common and sometimes occurred on a yearly basis. Those practices changed during the Great Depression of the 1930s, when numerous Americans became unable to make their regular mortgage payments due to the national economic crisis. Banks were largely unwilling or unable to refinance those loans, and as a result, numerous Americans lost their homes to foreclosure. In light of that crisis, newly created US government agencies such as the Federal Housing Administration (FHA) began to offer long-term mortgages, setting a trend that would spread throughout the subsequent decades. By the end of the twentieth century, thirty-year mortgages were common, although fifteen-year loans were also prevalent.

In the early twenty-first-century United States, mortgages play a crucial role in the home-buying process, as few Americans have the liquid funds needed to purchase a piece of real estate outright. As such, a mortgage loan often covers the bulk of a home’s purchase price, although buyers are typically required to provide a cash down payment and also cover certain fees associated with the buying process. A 20-percent down payment is typically considered standard, although individuals who qualify for certain first-time or low-income home buyer programs can at times pay as little as 3.5 percent down. In such cases, the mortgage loan can represent as much as 96.5 percent of the property’s purchase price. Current and prior active duty military members are eligible for a veteran's affairs (VA loan) and are not required to pay a down payment.

The ability of borrowers to afford their mortgage payments has been a significant concern for the US government since the Depression, when the era’s wave of foreclosures sparked the introduction of new regulations and federal programs. Over the next decades, however, and particularly in the late twentieth and early twenty-first centuries, predatory lenders found ways to offer sizable loans to people who could not truly afford them. During the global economic downturn that began in 2007, this practice contributed to numerous foreclosures, once again prompting the government to take action. The federal government ultimately introduced regulations requiring lenders to verify their borrowers’ ability to pay, through the passage of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, a broad piece of legislation that introduced significant reforms throughout the financial sector. In 2011, the Consumer Financial Protection Bureau was formed in order to help consumers by enforcing financial laws and monitoring banks. In 2018, President Donald Trump modified and scaled-down parts of the Dodd-Frank Act with the Economic Growth, Regulatory Relief, and Consumer Protection Act. This act gave small and midsized banks certain exemptions and less stringent oversight.

Overview

A mortgage loan is often the largest single loan an individual will take out in his or her life, and the financial obligation it represents should not be taken lightly. As such, the process of obtaining a mortgage incorporates numerous safety measures to ensure that the borrower understands his or her responsibilities in regard to the loan. By gaining a thorough understanding of the mortgage process and different mortgage terms, one can be better prepared for a future as a homeowner.

Choosing a Mortgage Provider

When beginning the process of obtaining a mortgage, one must carefully consider which mortgage provider best meets one’s needs. In some cases, one might base one’s choice of provider on which lender offers the most favorable interest rate and loan terms. However, there are other considerations that may influence one’s choice. An individual may prefer to borrow from a financial institution with which he or she already has a relationship, such as the bank that holds his or her personal accounts. For some prospective borrowers, a large national institution may be the most versatile option, while for others, a smaller lender such as a credit union or local bank may be more flexible in regard to the types of loans it offers. If one is a first-time or low-income buyer, one may qualify for a federal or state assistance program and must thus be sure that the provider one chooses participates in that program. Some prospective borrowers choose to secure the assistance of a mortgage broker when taking on this often time-consuming search.

Applying for a Mortgage

After selecting a loan provider, the prospective borrower must typically provide the lender with a significant amount of documentation in order to prequalify for a mortgage. By prequalifying, the borrower is able to determine the amount of money the lender is willing to loan and can thus submit offers on pieces of property with confidence. In addition to basic information such as the borrower’s address and social security number, the lender will often require that the borrower submit documents such as paystubs and tax returns. Such documents, along with a credit check, allow the lender to verify the borrower’s employment and income history and confirm his or her creditworthiness. This process is of the utmost importance, as it confirms whether the prospective borrower can truly afford the loan, in keeping with the stipulations of the Dodd-Frank Act. After the prequalified borrower’s offer on a property is accepted, he or she may be required to supply additional documentation confirming his or her financial situation and verifying that he or she has the funds necessary to make a down payment.

Mortgage Payments

The majority of mortgages require the borrower to make payments on a monthly basis. A typical mortgage payment consists of several parts: principal, interest, property taxes, and homeowners insurance (PITI). Principal refers to the money originally borrowed, while interest is a fee, based on a percentage of the principal, paid to the lender for the privilege of borrowing money. Although the borrower may handle tax and insurance payments himself or herself, lenders often require borrowers to pay the necessary amounts as part of their mortgage payments, holding the funds in escrow until the bills become due. Some borrowers, particularly those participating in a first-time homebuyer program, may also be required to make monthly payments for private mortgage insurance (PMI). Although most mortgage payments consist of principal and interest at a minimum, that is not always the case. Some lenders offer loans in which the borrower makes interest-only payments for a set number of years. While such loans may appeal to some borrowers, they are risky in that once the interest-only period is over, the monthly payments will increase dramatically, potentially rendering the borrower unable to pay. It is essential that one pay one’s mortgage payments, as defaulting on a mortgage loan typically results in the loss of one’s property.

Types of Mortgages

Although most mortgages share similar features, there are a variety of aspects that differentiate them from one another. Perhaps the most obvious of those is the term of the mortgage in years. Thirty-year mortgages are most common, followed by fifteen-year mortgages, in large part because long-term mortgages offer lower monthly payments; however, when factoring in interest payments, they tend to result in the borrower paying a significantly larger total amount by the end of the loan. Some lenders offer five-, ten-, or twenty-year mortgages, which have different financial ramifications than their thirty-year counterparts. Another key element of a mortgage is its interest rate—that is, the percentage of the original loan amount that the borrower pays to the lender as a fee. Interest makes up a significant portion of the average monthly mortgage payment, so it is important to take the interest rate a lender offers into account when applying for a loan. Perhaps even more important is the type of interest rate associated with the mortgage. Fixed interest rates do not change over time and are thus beneficial when market rates rise; however, if the prevailing rates decrease, the borrower cannot decrease his or her interest rate without refinancing the property. Adjustable interest rates change on a set schedule, often yearly, and fluctuate along with market rates. Hybrid interest rates combine elements of fixed and adjustable rates; for example, in a 5/1 adjustable rate mortgage, the interest rate is fixed for five years and can then be adjusted once per year during the subsequent years.

Bibliography

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