Important Features of a Mortgage Explained
A common aspiration by many is to purchase and own a house. It’s a life-changing decision because owning a house is basically a lifestyle change. However, thinking about the process is overwhelming. There is tremendous pressure. The apprehensions are understandable but it can be overcome. The best recourse is to have an understanding of the important features of a mortgage.
A Risk-Based Decision
Usually, deciding on a mortgage is mainly based on your financial capacity and stability. You don’t jump into the water just because you have a steady stream of income. The meter gauge is the ‘real’ cash you receive on a regular basis. Is it sufficient to pay for the amortization? Can you sustain the payments for an extended period?
Hence, the uncertainty of making payments is ever present. Unavoidable circumstances might arise that you’ll miss out on payments. Your unblemished credit record might be tarnished as a result.
Types of Mortgage
People avail of a home mortgage for two purposes – either to purchase a house or refinance an existing home. These are the two primary types of mortgage:
Home acquisition
The normal route to acquire your dream house is through a mortgage. An equity or down payment is required. A borrower puts up a down payment or equity at a minimum amount equivalent to 5% of the selling price. The remaining balance becomes your mortgage loan.
A mortgage loan is considered conventional when the down payment is higher than 20%. Keep in mind that the higher the down payment, the lower is the amortization. Further, a down payment below 20% translates to a longer repayment period. Thus, the term or period within which to pay the mortgage can be as long as 25 years. That is also the maximum period allowed.
If a borrower shells out a down payment less than 20%, the loan is categorized as a high- ratio mortgage. Thus, lenders would require mortgage default insurance which is mandatory. The insurance premium you will pay is an added expense. It serves as a protection to the financial institution in the event of default.
Home refinancing
There are various reasons why the home refinancing is an attractive facility for homeowners. Your existing house can be used as collateral to secure a mortgage loan. The amount is based on a percentage of the appraised value of your house or as agreed upon with the lending firm.
The purpose and utilization of the proceeds may be as follows:
- Home renovation, facelift or repairs
- Working capital for a business or making an investment
- Debt consolidation
- New mortgage due to lower interest rates
Home refinancing also has different schemes that can adapt to your financial situation. Besides a new mortgage, you have the option to apply for a credit line. It is a revolving line with the variable interest rate. You only pay for the amount that you withdraw from the credit line.
Another salient feature of home refinancing is flexibility. You can customize by combining a mortgage loan with a revolving credit line. Review your cash flows to see where you can mitigate the risk, derive savings, and make repayments lighter.
Factors for consideration
There are factors you need to consider whether you’re purchasing a house or refinancing your own domicile.
Interest rate
Borrowers are naturally ‘rate conscious’ when applying for a loan. The interest rate is the primary consideration. For all intents and purposes, the lowest rate offer is the obvious preference.
The next consideration is whether you’ll go for a fixed or variable mortgage rate. For first-time home buyers, the likely choice is the fixed rate mortgage.
Fixed-rate mortgage
The interest rate on your mortgage is fixed, which means you pay a uniform amortization payment for the entire period of the loan.
Upside:
- Since payment is pre-determined, it becomes easier for budgeting purposes.
- The borrower is shielded from any upward increase in current mortgage rates.
Downside:
- If interest rates are on a downward trend, you are locked-in with a higher interest rate.
Variable mortgage rate
A variable mortgage rate or adjustable-rate mortgage (ARM) means the interest rate changes from time-to-time or during adjustment periods. Thus, the amortization payments vary as well.
Upside:
- The interest rate is considerably lower than the fixed-rate, usually during the first few years. Savings are realized during this period.
- Lower rates at the beginning could also bump up the borrower’s loanable amount.
- This is the ideal option when the market scenario is falling interest rates. It also eliminates the option of refinancing.
Downside:
- Frequent changes in the amortization schedule make budgeting more tedious.
- Higher amortization amount with upward rate adjustments and financial impact is significant for larger loan amounts.
- The rates are constant for a specific period but will change on set adjustment periods. New rates will be aligned with the prevailing mortgage rates.
- Over time, the interest rate will exceed the going rate for fixed-rate mortgages.
Mortgage Options
Interest rates range from 3.0% to 7.0% APR (annual percentage rate) depending on the mortgage facility you choose. Within these rate offerings, banks and other financial institutions have schemes to tailor-fit the mortgage loans.
- Open Mortgage
This scheme allows a more liberal payment structure. The borrower can pay off a mortgage at any time prior to the maturity date. No prepayment will be charged but the interest rate applied on an open mortgage is higher. - Closed Mortgage
A closed mortgage is non-negotiable requires, meaning the die is cast. Everything is set payments, schedule, and prepayment penalties. Although the rate is lower versus an open mortgage, you do not have room to renegotiate, refinance or transfer your mortgage before the loan maturity. Your way out is to pay the pre-termination penalty or charges.
Study the prepayment options
Paying for a long-term mortgage would seem like an eternity. Everyone desires to fully pay the loan the soonest time possible. But due to financial limitations and affordability, it’s a long wait before the house can be called your own.
Nonetheless, you can accelerate or reduce interest cost as mortgages, fixed-rate or variable, allows prepayment or lump sum payments. Inquire from your bank or lender about their prepayment provisions. If you have the means to pay extra, this strategy can reduce the outstanding balance while simultaneously saving on interest cost.
Making A Firm Decision
You do not spin the decision wheel when choosing a mortgage option. After learning the important features of a mortgage, you can decide with firmness and confidence. Making a mistake in a life-changing event is no longer an option.
