Purchasing a home involves getting a mortgage. A mortgage is a written pledge of property used as security for the repayment of a loan. The property you purchase is the collateral for the mortgage loan. If you fail to make payments on the loan, the lender can repossess your home. As a result, the lender has some legal rights, called a lien, on your property as you pay off your mortgage. Unlike a standard loan, the mortgage is used to enforce the lender's rights to the property if the borrower does not repay the home loan.
The fixed monthly payment for a fixed rate mortgage is the amount paid by the borrower every month that ensures that the loan is paid off in full with interest at the end of its term. This monthly payment, c, depends upon the monthly interest rate, r, (expressed as a fraction, not a percentage, i.e., divide the quoted yearly nominal percentage rate by 100 and by 12 to obtain the monthly interest rate), the number of monthly payments, N, called the loan's term, and the amount borrowed, P0, known as the loan's principal; using the following formula:
Definition of formula from pedia.org
If the borrower does not keep up with his/her monthly mortgage payments, the lender can obtain the home through what is called foreclosure. Foreclosure is the forced sale of a home or property that is pledged as security against a mortgage. The property is sold so the lender can recoup its losses on the loan.
Home mortgage loans are most commonly offered over from 15 to 30 year 'terms'. The term is the amount of time over which the mortgage loan must be repaid.
The interest rate on most mortgages is either fixed-rate or adjustable-rate. The interest rate is the percentage of the loan amount that the borrower must pay to the lender each year for lending them the money. Loan payments typically consist of both an interest payment and a so-called 'principal' payment that reduces the loan balance.
In a fixed-rate mortgage, the interest rate and monthly payment do not change. They remain constant throughout the term of the loan. In an adjustable-rate mortgage (often called an ARM), the interest rate is fixed for a period (typically 3 to 10 years) and then changes (typically every year) from then on. Monthly payments on ARMs will change as the interest rate changes.
What happens if interest rates change?
If I have a fixed rate mortgage, nothing changes - even if rates rise or fall substantially my rate and payment do not change. If rates rise, this is a good thing; I am protected. If rates fall, on the other hand, this may not be good; I may be paying more for my mortgage than I need to be. If rates fall substantially, I may need to consider mortgage refinancing to lower my rate, payment, and total cost.
If I have an adjustable rate mortgage, on the other hand, and the initial fixed rate portion of my loan is past, I am not protected - if rates rise my rate and payment may increase substantially, but if rates fall I am happy. Although the initial fixed rates on ARMs are frequently a lot lower than those on fixed rate mortgages (which can be very appealing), many borrowers avoid these mortgages because of this riskiness.
If you're about to buy a home, be aware of how your standard mortgage operates, and establish early on if you have the finances to afford a mortgage. If you get involved in a mortgage and later discover you can't afford it, it could cost you your new home.
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