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What is a mortgage?

Learn what a mortgage is and the varieties of mortgages available.

A mortgage is a debt taken out on a commercial or residential property. [©Jupiter Images, 2010]
©Jupiter Images, 2010
A mortgage is a debt taken out on a commercial or residential property.

It is not uncommon for first time homeowners to ask, What is a mortgage? There are even some seasoned homebuyers who feel in the dark about mortgages. This is partially due to the fact that mortgages are extremely complex. There are various types of conventional and government-sponsored mortgages, all of which have varying conditions. Learning the details of various mortgages can save prospective homeowners many frustrations.

The Mortgage Defined

In a broad sense, mortgages are defined as a type of debt that is backed by the actual property on which the mortgage is taken. Individuals or businesses take out mortgages on residential or commercial properties. This debt is the responsibility of the borrower and must be paid back to the lender through a set of payments that are spread out over a particular period of time. If the borrower fails to follow through on payments, the lender has the right to evict the borrower and sell the property. The lender uses the profits from the sale of the property to clear the debt owed by the borrower.

Conventional and Government Mortgages

The Federal Reserve Board describes conventional mortgages as mortgages that are not insured by the government. Conventional mortgages fall into one of two categories: fixed rate or adjustable rate. Adjustable-rate mortgages have fixed interest rates for a set period of time; however, once this period ends, the interest rate adjusts according to current market conditions. Fixed-rate mortgages have a fixed interest rate for the entire length of the mortgage.

Government mortgages are government insured. There are several types of government mortgages available, including mortgages through the Federal Housing Administration, the Veterans Administration and the Farmers Home Administration. The FHA explains that their FHA-backed loans offer various perks, including:

  • Competitive interest rates
  • Small down payments
  • Easier qualifications
  • Options for borrowers with less-than-perfect credit
  • More protection for the home
  • Both adjustable- and fixed-rate loans

The U.S. Department of Agriculture's Rural Development Housing and Community Facilities Program offers rural individuals and families the opportunity to pursue homeownership through direct loans, a mutual self-help housing program, home repair and preservation programs, and listings of homes for sale. The VA offers VA-guaranteed loans through participating lenders. In order to be eligible for such loans, applicants must obtain a certificate of eligibility.

Subprime Loans

Subprime loans are offered to people who do not qualify for prime rate loans. Generally, subprime borrowers have difficulty obtaining a loan because they have low credit scores or are a high risk for lenders. Most subprime loans have higher interest rates. The rates for subprime loans vary from one lender to another, so it is important for subprime borrowers to consult with many different lenders to obtain the best rate possible.

Reverse Mortgages for Seniors

There are many advertisements on television touting the advantages of reverse mortgages. The U.S. Department of Housing and Urban Development defines reverse mortgages as a special type of home loan that lets a homeowner convert the equity in his or her home into cash. While private lenders may offer reverse mortgages, the FHA has its own reverse mortgage program known as the Home Equity Conversion Mortgage (HECM). In order to qualify for this program through the FHA, applicants must be at least 62 years of age or older. In addition, applicants must either own their home completely or have a small remaining balance, and applicants must reside in the home. Homes eligible for this mortgage program are one- to four-unit homes.

Esoteric Aspects of Mortgages

There are several terms associated with mortgages that borrowers may find unfamiliar and confusing. While these terms may not be familiar to the borrower at the outset of the mortgage search, they should be familiar with them prior to making any decisions about mortgage products.

One term, debt-to-income ratio, represents the ratio between a person's monthly debts to their monthly income. This ratio is typically presented as a percentage, and the acceptable percentage may vary from one type of loan to the next. Another term, earnest money, refers to an amount of money that is offered by the seller to the buyer or agent. This money represents the buyer's good faith in negotiations. The buyer loses this money if the deal falls through as a consequence of the buyer's actions.

Additional terms include points, loan-to-value ratios and loan origination fees. The points on a mortgage reflect the finance charge that is paid in advance. One point represents 1 percent of the loan amount. The loan-to-value ratio is a ratio between the amount of the loan being taken out and the property's appraised value. The loan origination fee refers to the amount the lender charges for processing the loan.

Mortgages for Sale

Recently, some borrowers have been shocked to learn that their mortgages have been sold to other lenders. This happens for a variety of reasons. In many cases, the original lender merges with another company, assuming a new name. In other cases, the original lender becomes overburdened with obligations and decides to sell some of their loans to lighten their load.

Bankrate notes that when a mortgage is turned over to another lender, there are certain requirements that must be met. First, both lenders, including the original lender and the new lender, must notify the borrower of the transfer in writing. This notification must state the date that the transfer will become official and must provide the contact information for the new lender. All new lenders are obligated to honor the terms of the original loan. In addition, borrowers should be informed of any changes to their homeowner's insurance. Borrowers are allowed a 60-day grace period, during which they cannot be charged late fees for payments sent to the previous lender. If the borrower has a dispute with their new lender, they may write the new lender about the concerns. The lender is legally obligated to resolve the issue within 60 business days.

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