What is a mortgage?
Let’s start with the ultra basic. What is a mortgage?
A mortgage is defined as a temporary, conditional pledge of property to a creditor as security for performance of an obligation or repayment of a debt.
What this means in layman terms is that a bank allows you to assume the ownership of a piece of property so long as you repay the cost of that property under a set of rates and terms as defined by the bank.
A mortgage can be referred to in a variety of different ways. Some call the mortgage a “lien”, which is the amount of money a borrower owes on a property. Whatever is left over from the original loan amount is called the existing lien(s). Others might refer to the mortgage as a trust deed, or deed of trust, which is just the legal document that outlines the terms of the agreement.
A bank, otherwise known as a lender will loan you a specific amount of money that will need to be repaid in “X” amount of years at “X” interest rate. Assuming you qualify, the bank will grant you a loan and you will go into contract with that bank and begin making regular monthly payments until your mortgage is paid in full.
There are three main types of mortgage transactions:
Purchase
Most mortgages are based on a 30 year amortization. That is, the total loan amount, or lien(s) will need to be paid off in 30 years, or 360 months. Please also note that there are other less common loan terms such as 15 year, 20 year, and even 50 year loan programs. But for the sake of simplicity, let’s focus on the 30 year amortization type.
When searching for a loan program, you will be presented with a variety of options from a 1 month product to a 30 year fixed product. Both are based on 30 years amortization, but the differ greatly in rate. The 30 year fixed product is pretty clear. It is simply a fixed rate for the entire 30 years of the loan. It never changes, and the rate you pay the first month is also the rate you will pay the last month, or the 360th month to be exact.
The 6 month product is a bit more complicated. For the first six months the rate will not change. But after those initial six months, the rate will become variable, though still based on a 30 year amortization. The loan program will be tied to a mortgage index, such as the LIBOR (London Interbank Offered Rate) and will also contain a margin agreed upon by the bank or lender. When you combine the two, you will find your monthly rate. The margin doesn’t adjust, but the index will do so on a daily basis, which will affect the rate you pay monthly. The only saving grace to this type of program is the caps, which limit the amount a rate can change. They tend in come in three types:
Initial: The amount the rate can change at the time of the first variable period. In this case, after the first six months.
Periodic: The amount the rate can change during each period, which in this case is every six months.
Lifetime: The amount the rate can change during the life of loan. So throughout the full 30 years, it can’t exceed this amount.
The caps at the company I used to work for were 6/2/6, meaning after the first six months is up, the rate you initially paid can move up or down 6%, although the rate will never go to 0%, and will likely have a floor rate, which is either the original start rate, or something determined by the lender such as 2% below the original start rate. Then each six months, it can go up or down 2%, and throughout the life of the loan it can go up 6% TOTAL from where it initially started. So if you’re start rate was 6%, after six months it could rise to 12%, which is also the life cap, so it couldn’t go beyond that, but it could potentially drop 2% to 10% after another six months. Yes, the caps work both ways, in case rates happen to improve.
