For many people, owning your own home is the cornerstone of the American dream. But up until the 1930s, most families didn’t own their own homes. Without specially-designed loans for buying homes, owning the family home was off-limits to most.
That was until the modern mortgage as we now know it came into existence and changed everything.
But how does a mortgage work?
In this article, we’ll look at mortgages and discuss how they work.
What is a Mortgage?
The word mortgage comes from the old French for death (mort) and pledge (gage). Essentially, a mortgage is a death pledge. It’s not as grim as it sounds though, it doesn’t literally mean that.
What a mortgage actually meant was that once the debt was paid, the pledge would die. And, if the debt wasn’t repaid, then the home would be forfeited.
Put simply; a mortgage is a specialist loan for buying a property.
In a mortgage, the lender will agree to lend the borrower money for an agreed period of time in exchange for ownership of the property and interest payments. If the borrower doesn’t repay the debt, the lender can repossess the property.
Once the entirety of the loan is paid off, the full ownership of the property will then transfer to the borrower.
What is the History of Mortgages?
Mortgages were first mentioned in the history books in England in 1190. However, they would have been quite different from the types of mortgage we see today.
Mortgages of a sort existed in America towards the end of the 19th century; however, you would need to be very rich to take one out. You’d pay a 50% downpayment on the property, and then you would have just five years to repay the remaining 50%.
To be eligible for this type of mortgage, the lender had to know you, or you needed to be vouched for. Your creditworthiness wasn’t based on income or a credit check; they were more concerned about your social standing.
Following the great depression, Roosevelt launched the new deal to kick start the economy. This led to the creation of the modern mortgage.
In 1934, the downpayment that you’d need to stump up at the start of the loan was lowered. The Federal Housing Administration (FHA) started to set up loans with LTVs (loan-to-value) of 80%, 90%, and higher. Soon, the commercial banks followed suit.
The FHA also changed the length of their loans. First of all, offer 15-year mortgages and then later extending these to 30-years.
Next, the FHA got involved in ensuring that properties were built to last. With longer-term mortgages, it was essential that the home outlived the loan.
Finally, they also changed the eligibility for the mortgage. You no longer needed to know someone to be eligible for a loan. Instead, you would be assessed on your ability to pay the debt back.
Downpayments and Monthly Payments
When you take out a mortgage, you will be required to make a downpayment. Traditionally this is 20% of the purchasing price; however, it is possible to find loans that let you put down as little as 5% or even 3%.
The more you put down at the start of the loan, the less you’ll need to pay overall, and the lower your monthly payments will be.
Each month, you’ll need to repay a portion of the debt. This will include interest.
Fixed-Rate and Adjustable-Rate Mortgages
There are several types of mortgage available. The most common are fixed-rate and adjustable-rate mortgages.
With a fixed-rate mortgage, you’ll pay the same rate of interest throughout the life of the mortgage. Not only will your interest remain the same, but your monthly payment will also not change. The only changes you’re likely to see will be in any taxes and insurance payments.
The interest rate you’re offered will be based on your credit score and length of the loan.
With adjustable-rate mortgages (ARM), the interest rate will change annually based on the condition of the market.
Your mortgage lender would have to wait a very long time to make money off your mortgage if it wasn’t for origination fees.
Origination fees are a percentage of the total loan and are usually between 0.5% and 1%. When considering your mortgage, it is always important to check out the origination fees before deciding who to borrow from.
What is APR?
Calculating interest is one of the more complex elements of taking out a mortgage. The annual percentage rate (APR) allows you to compare the values of loans.
The APR on a mortgage will always be slightly higher than the interest rate that the lender is charging you because it will carry with it most of the other fees, such as the origination fee.
The cost of your mortgage is more than just the monthly payments. You need to also pay closing costs.
Closing costs are the legal fees associated with the transferal of the deeds and title of the property, as well as the handling fees for your attorney or escrow holder.
Remortgaging Your Property
Personal circumstances change as you progress through life, and you may find that you need money. You can free up some of the money you have paid off your property by refinancing a mortgage.
Remortgaging will reset your mortgage back to the start, but you’ll be able to spend the equity that you’d built up in the property in the meantime.
How Does a Mortgage Work?
How does a mortgage work? In a nutshell, a mortgage lets you place a downpayment of between 3-20% down on a house; you’ll then repay this monthly in a period of up to thirty years.
There are several types of mortgage available, and it is always best to read the small print and work out exactly how much the borrowing is going to cost you.
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