What Is a Mortgage?

A Guide to Understanding Home Loans

A mortgage is a type of loan that is used to finance the purchase of a home. Bank of Internet USA offers multiple mortgage options designed to meet the financial needs and goals of a diverse range of home buyers. All mortgages, however, have certain components in common.

What are the components of a mortgage?

  • Collateral: The house you purchase serves as collateral for the mortgage. If you fail to repay the loan, the bank can take back the house in lieu of repayment.
  • Principal and Interest: Principal refers to the amount of money you borrow to finance your the purchase of your home. The interest is the additional amount of money you agree to pay, usually expressed as a percentage, in order to use the principal amount.
  • Taxes: The taxes you pay on your property are generally proportional to the value of your home.
  • Insurance: In order to close the deal on your home, you will have to acquire homeowner's insurance. Depending on the type of mortgage, the terms of that mortgage, and the down payment you are able to make on the home, you may also be required to get Private Mortgage Insurance.

Call 1.888.546.2634 to speak to a friendly, expert BofI USA Mortgage Consultant who will create a loan package that is just right for you.

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Mortgage Basics

At , we want to provide you with all of the information you need to make confident, educated decisions about your finances. It is important that you clearly understand the basics of a mortgage before you apply for financing, especially if . Understanding your mortgage loan can help you avoid some of the more .

In simplest terms, a mortgage is a loan used to finance the purchase of a home. The loan is secured by the property you purchase and represents a legally binding contract. For most people, a mortgage represents the largest debt they will ever assume, as well as the longest contract they will ever enter into. Most mortgages last between 15 and 30 years.

Mortgages are composed of several components—the collateral used to secure them, the principal and interest payments, taxes, and insurance. In addition, there are fixed rate mortgage loans and adjustable rate mortgage (ARM) loans.

Collateral

When you enter into a mortgage agreement with a bank, you’re signing a legal contract. According to the terms of that contract, you promise to pay back the loan, plus any agreed-upon interest and costs associated with the mortgage lending process. In order to secure the funds to purchase your new house, you use the house itself as collateral for the loan. This means that, if you fail to repay the loan, you agree that the bank can take back the house in lieu of repayment.

Principal and Interest

In mortgage lending, principal refers to the amount of money you borrow to finance the purchase of your home. You can lower this amount by making a larger down payment up front. Ideally, you will be able to make a down payment of greater than 20 percent.

The interest is the additional amount of money you agree to pay the bank in order to use the principal amount as payment for your new home. The interest rate is commonly expressed as a percentage. Your interest rate will depend on many factors, including whether you opt for a fixed rate or adjustable rate mortgage.

Together, principal and interest will make up most of your monthly payment. Through a process called amortization, the principal and interest payments will be strategically broken up so that your initial monthly payments will go primarily toward paying down your interest, while your later monthly payments will go primarily toward paying down your principal balance. The purpose of amortization is to save you money in the long term.


Discount Points

are influenced by many factors, including the state of the overall economy, treasury 10-year bond prices, debt markets, and the Federal Reserve Board’s monetary policy, all of which change over time. As these factors fluctuate, so do mortgage rates.

Discount Points can directly affect your mortgage rate. Discount Points are fees that you pay directly to your lender at close in exchange for a lower interest rate over the life of your mortgage. As a result of this one-time payment, also known as a prepaid interest payment, you will have a lower monthly mortgage payment.

The cost of each Discount Point is equal to 1 percent of the principal loan amount. Therefore, if your principal loan amount is $200,000 mortgage, one Discount Point would equal $2,000. It is possible to break Discount Points into fractions; for example, if your principal loan amount is $200,000, 1.50 Discount Points would equal $3,000.

Whether paying Discount Points makes sense in your case depends, in part, on how long you plan to stay in your home. To help you decide whether you should include Discount Points as , use these steps when calculating your mortgage:

  1. Calculate the amount of your monthly payment at the interest rate you would be charged if you do not pay Discount Points.
  2. Calculate the amount of your monthly payment at the lower rate if you were to pay Discount Points.
  3. Deduct the lower payment from the higher payment to find the amount you would save each month.
  4. Divide the amount charged for Discount Points at closing by the amount you would save each month. The result is the number of months you would have to stay in your home in order to reach the break-even point on on paying Discount Points.

Taxes and Insurance

Your mortgage payment will also likely include taxes and insurance. If these are paid as part of your mortgage payment, they will be paid through an escrow account.

Property taxes are levied by your community and are calculated as a percentage of the value of your property. They are usually used for local costs such as schools, roads, and public services. Determining the taxes you will have to pay on your property is a , and you should keep this amount in mind as you consider how much of a mortgage payment you can afford.

In order to obtain a mortgage, most lenders require that you have a home insurance policy in place, which covers your home and personal property against fire, theft, and other damage and losses. If your property is located in a special flood hazard area, you will be required to carry flood insurance, as well.

There are also cases in which you will be required to obtain additional insurance before being eligible for a mortgage. If you put down less than 20 percent on a , your lender will probably ask that you get Private Mortgage Insurance (PMI) until you have made two years' worth of payments or your principal balance is reduced to 78 percent of its original amount. This PMI protects the lender in case you default on the mortgage. If you select a loan backed by the , you’ll also have to pay mortgage insurance. This functions the same way as PMI, except that you must make payments for 11 years or the life of the loan, depending on your terms.

Mortgage Types

There are two basic types of mortgage loans: fixed rate and adjustable rate.

Fixed Rate Mortgages

A fixed rate mortgage is a loan with a set interest rate that does not change over the life of the loan. Fixed rate mortgages allow home buyers to spread out the cost of such a large purchase by making smaller, predictable payments over a long period of time, usually between 15 and 30 years. The terms of fixed rate mortgages tend to be relatively easy to understand and make future financial planning straightforward. Fixed rate loans are generally well-suited to people with steady, predictable sources of income and who plan to own their homes for a long time.

Adjustable Rate Mortgages

An adjustable rate mortgage (ARM) is a loan in which the interest rate changes over the life of the loan. When this happens, the monthly payment is adjusted according to the new interest rate. Adjustable rate mortgages generally offer an initial interest rate that is lower than current fixed rates for a pre-determined period of time. After that period elapses, adjustable rate mortgages fluctuate in accordance with the current interest rates. This may be a good option for borrowers who plan to move or refinance following the fixed rate period, as well as those who do not mind carrying the volatility of a fluctuating rate and monthly payment.

If you are interested in obtaining a mortgage to finance the purchase of a home or refinancing an existing mortgage to more favorable terms, we invite you to contact one of our Mortgage Consultants to review available options. To get started, please fill out the form on this page, or call us now at 1.888.546.2634.