Understanding Mortgage Terms: A Simple Guide

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Before diving into the home buying process, it’s essential to understand mortgage terms, like what a mortgage is and how it works. Put simply, a mortgage is a loan secured against a real estate asset, with payments charged at a prescribed interest rate. Here’s a breakdown of traditional mortgage terms to help you navigate your mortgage contract effectively.

Example of a Mortgage Contract

Loan

  • Purchase Price: $105,265
  • Down Payment (5%): $5,265
  • Net Mortgage: $100,000
  • Mortgage Default Insurance: $4,000
  • Total Mortgage: $104,000
  • Loan to Value: 95%

Terms

  • Interest Rate: 1.95%
  • Term: 5 Years
  • Amortization: 25 Years
  • Style: Closed
  • Type: Fixed

Payment

  • Principal and Interest: $438
  • Estimated Property Tax: $1,200
  • Taxes Paid By: Lender

Key Components of a Mortgage Contract

Purchase Price

The purchase price is the agreed-upon amount you will pay to buy the home. It’s the starting point for calculating your mortgage.

Down Payment

The down payment is the money you provide out of pocket for the real estate transaction. Typically, it is a percentage of the purchase price, with the rest being covered by the mortgage lender.

Net Mortgage

This is the amount of the loan after deducting your down payment from the purchase price. For example, if the purchase price is $105,265 and your down payment is $5,265, the net mortgage is $100,000.

Mortgage Default Insurance

If you put down less than 20%, mortgage default insurance is mandatory. This insurance protects the lender if you stop making payments. The premium for this insurance is added to your mortgage amount rather than paid upfront. In our example, the insurance premium is $4,000, making the total mortgage $104,000.

Total Mortgage

The total mortgage amount includes the net mortgage plus any mortgage default insurance. This is the amount your mortgage payments are based on.

Loan to Value (LTV)

The loan to value ratio is expressed as a percentage and represents how much of the home’s value is financed by the loan. For instance, with a 5% down payment, the LTV is 95%, meaning 95% of the home’s value is covered by the mortgage.

Understanding Mortgage Terms and Conditions

Interest Rate

The interest rate is what the lender charges for borrowing money. This rate, combined with the amortization period, determines your monthly mortgage payments. In our example, the interest rate is 1.95%.

Term

A mortgage term is the length of time you agree to the current mortgage rate, terms, and conditions with your lender. Commonly, terms are five years. During this period, you are expected not to break the mortgage. If you do, penalties may apply. In our example, the term is five years at an interest rate of 1.95%.

Amortization

Amortization is the total period over which you plan to pay off your mortgage. If you have less than a 20% down payment, the maximum amortization period is 25 years. With a 20% or higher down payment, you can extend this period to 30 years. Shorter amortization periods result in higher payments, but less interest paid over the life of the mortgage. Conversely, longer periods reduce monthly payments but increase overall interest costs.

Example:
Consider a $100,000 mortgage at a 3% interest rate with a 25-year amortization. Monthly payments would be approximately $473. If the interest rate rises to 3.5% at the end of the five-year term, your monthly payments would increase to about $499, assuming a constant amortization period of 20 years remaining.

Final Thoughts

Understanding mortgage terms is crucial for making informed decisions about your home financing. By knowing the components of your mortgage contract and how they affect your payments, you can better navigate the home buying process.

If you have any questions or need assistance with your mortgage, reach out to Alex Lavender, your trusted mortgage broker. He can provide expert advice and help you secure the best terms for your home loan.

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