Mortgage is a term that everyone is familiar with, but that no one tends to look very deep into until they find themselves in a position of needing one. They can be a little tricky to navigate, so it’s important to take some time to understand the ins and outs of how they actually work before setting out to secure one of your own.
If the time has come and you’re thinking about buying a home, here are a few points about mortgages that can help you feel more comfortable, and more educated, going into the process.
1. You’re paying down two totals with your monthly payments
First things first, you need to understand the terminology of how the money you borrow, owe, and are paying back is referred to. The initial amount of money that you borrow with your mortgage is known as the principal. Each month, part of your monthly payment will go toward paying off that principal, or mortgage balance, and a separate part of the payment will be going toward interest on the loan. Interest is in addition to the principal and is what the lender charges you in exchange for lending you the money.
2. Monthly payments don’t add up to equity
Considering how these two different amounts exist and interact, it is important to understand that the part of your payment that goes to principal reduces the amount you owe on the loan and builds your equity. Meanwhile, because the part of the payment that does to interest exists separately, it doesn’t reduce your balance or build your equity. Therefore, the final equity you build in your home will actually be a fair deal less than the cumulative sum of your monthly payments.
3. A mortgage doesn’t necessarily equal a good investment
Although buying a home is generally seen as a big milestone in terms of making an “adult” or mature decision, it is important to make such a big decision wisely. Buying a home is a big deal and if you have to get a large mortgage in order to do so, you need to understand that the vast majority of your net worth is going to be tied up in one place. The old saying rings true here too, beware of putting all your eggs into one basket.
With that being said, it is true that you need to pay to live somewhere, and it is likely that you’ll end up with some equity in your home. You just need to go into the process aware that housing markets are cyclical, there are ups and downs and you shouldn’t expect to be able to sell your home easily anytime you like.
4. Interest rates can be either fixed, variable or convertible
Understanding the type of interest rate you have is also crucial. Luckily, the names don’t conceal much here. For example, a fixed interest rate does not fluctuate throughout the length of the mortgage term and you will be making consistent payments over a set number of years, a method which can provide borrowers with peace of mind.
Alternatively, a variable interest rate can change depending on economic conditions. As the interest rate increase or decrease over the course of the term, borrowers are required to adjust their payments accordingly. A convertible mortgage is essentially a combination of two, or rather, a mortgage with a variable rate with which the lender provides an option to fix the rate for the remainder of the term.
5. Mortgages can be either open or closed
When opting for an open mortgage, home buyers have the ability to additional contributions towards the total amount owed on top of regular payments, providing the opportunity to pay down the balance quickly. On the other hand, closed mortgages have restrictions on when payments can be made, so borrowers can even incur penalties if they opt to pay above and beyond the terms of the mortgage.