Mortgage 101 – How the Process Works

With Mortgage 101, most homes in the U.S. cost several hundred thousand dollars, but most Americans don’t have anywhere near that much money sitting around, and saving it up while also paying rent somewhere can take a lifetime. Fortunately, there are people (or more accurately, companies called banks) out there who have plenty of money, and there’s a very common, win-win situation that will make it worth their while to lend you money for a house.

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Mortgage 101

A person who wants money (the borrower) borrows some from a person who has it (the lender). This is called a loan. The borrower uses the money to buy what they want, then they pay the money back, plus a little extra. This extra is called interest, and is calculated as a percentage on top of the money borrowed (generally 3-6%, depending on a number of variables). This interest is the lender’s incentive for loaning the money in the first place; they make their money work so they don’t have to (which is one of the many reasons it can be fun to have a lot of money). Loans used to buy a house are called mortgages, and with most mortgages, the borrower has 10, 15, 20 or 30 years to pay back the total amount, with the 30-year mortgage being by far the most common.

See how interest rates affect my mortgage payment

Mortgage 101Payments are made every month for years, until the loan is paid off, which is when you can say you truly own your house. As long as you have a mortgage, your bank has a lien, or first dibs on the house if you don’t make payments. With most mortgages, your payment will be the same amount every month. There’s a lot of interesting stuff to be learned about how those payments break down as principle (the amount borrowed) and interest, but that’s a completely different lesson. What matters for now is how much money you’ll need to pay each month to be able to buy the house you want.

Collateral

When a bank lends a borrower money, they want some assurance that the borrower will pay the money back. If the borrower defaults, or doesn’t make their payments, the bank can kick the borrower out and sell the house to someone else (this is called foreclosure). But banks don’t particularly like foreclosing, because while they’re good at lending money and cashing checks, they aren’t good at fixing and flipping houses. To help the bank feel warm and fuzzy about you making all your payments on time, you can put a down payment on the property–that’s where you pay part of the purchase price yourself, traditionally 20%, and the bank lends you the rest. So on a $200,000 home, you might make a $40,000 down payment, and take out a mortgage for $160,000. If you default and the bank forecloses, they may never get the $160,000 back from you, but they can kick you out and resell your home for $200,000. They make $40,000, and you lose $40,000, so you have a big incentive to make your payments!

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Here’s an example

The average (median) home in the U.S. sells for around $200,000. In regard to Mortgage 101, the average interest rate for a 30-year mortgage–as of the beginning of 2015–was about 3.7%.  So if the borrower pays 20% down, their monthly mortgage payment will be $736.45. This is fairly affordable for the average American, generally cheaper than renting a similar property, and after 30 years, they don’t have to pay any more–they own it free and clear! But the lender also makes out well, because over the course of those 30 years, they borrower will pay them $105,123 in interest! Win-win! This article discusses how different variables affect your monthly mortgage payment.

Where to get a mortgage

With Mortgage 101, it may seem like a rare thing to find someone with $160,000, or even more, that they’re willing to let you borrow for 30 years. But the truth is, one can barely walk outside and randomly throw a stale cupcake in the air without it coming down on some mortgage broker or banker actively looking for someone they can lend money to. They’re everywhere!

Of course, before you get on the hook for such a huge commitment, you’ll want to make sure you’re not getting sold a bad loan. There’s a huge incentive (money!) for greedy lenders to rope you in to deals where you’re paying too much, or where you could get some surprises that wind up costing you your home. In 2008, many Americans wound up getting foreclosed on because they had inadvertently bought a bad mortgage from a “predatory lender”. Mortgage agreements, like any contract, are printed on plain white paper, but they’re stacked so thick they can stop a bullet. And the language is so thick it can stop your brain. Make sure your lender is reputable, comes highly recommended, and has your best interests in mind. Remember, lenders make over $100,000 on a very average mortgage. There’s plenty of money to be made honestly. But that doesn’t stop the bad apples from getting greedy now and then.

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