A mortgage arises when a person leases his land as a security for loans. The financial institution or individual that lends money and takes land as security has therefore created a mortgage.
There is generally a mistaken impression that a mortgage only refers to a loan for the purpose of buying or building a house. This is too narrow a definition. Mortgage refers, not to the purpose of the loan, but to the security that is offered. For example, if someone takes a loan to send a child to study and offers Title as security, then he/she has given you a mortgage. Also if someone takes a loan to go on vacation and gives you a Title as security for this loan, then a mortgage has arisen.
The lender or the financial institution who accepts your Title as security and provides the funding is referred to as the Mortgagee.
The individual who borrows the money and who creates the mortgage by offering his land Title as security is called the Mortgagor.
A mortgage loan is usually amortized over an agreed period, sometimes as long as thirty years, and generally covers a fixed repayment amount. If you can manage a shorter period, by making higher monthly payments, then you will realize savings on interest and payout the mortgage much sooner.
Traditionally, the terms on mortgages have varied. Currently on the market there are mortgages of thirty years, twenty years, and ten years.
The mortgage payments are made up of: -
· Interest, which is the cost of borrowing the money;
· Principal, which is the amount of money borrowed.
In the early years of the mortgage loan, a greater part of the monthly payment is applied towards the interest payments, while a smaller amount is applied towards the principal repayments. In the latter years, the reverse situation takes place; a greater portion of the repayment is applied towards the principal and a smaller amount is applied towards the interest.
Most institutions will require a minimum downpayment, which is generally estimated at about 10 per cent of the overall mortgage loan. Sometimes, it is as low as 5 per cent. Some institutions may vary that requirement from time to time. The financial institution requires customers to take some risk by making a contribution in the form of a downpayment. It helps develop discipline in persons to repay their mortgage and to safeguard their asset. There are institutions that may give 100% of the loan, where special conditions are applicable.
Mortgage payment can be made using the following options: -
· monthly payments;
· weekly payments;
· bi-weekly payments.
A borrower should decide on a payment option that best suits his/her financial situation.
Ways of Saving on Interest Payments
The possibility of paying one’s mortgage bi-weekly or monthly is an option that should be discussed with the lender. If someone pays fortnightly or bi-weekly, he/she would realise savings on interest as compared with paying monthly.
There are other ways in which homeowners can save on the interest as follows: -
· Taking advantage of prepayment opportunities;
· Shortening the repayment term; i.e. the amortization period from thirty (30) years to twenty-five (25), twenty (20), Fifteen (15), or ten (10) years, if you can afford. This will result in savings on interest payment. You should find out if it is possible to advance your mortgage payments? And by how much?
· Some financial institutions will allow Borrowers to reduce the principal debt at any rate.
Other Matters Related to Mortgage Loan
A mortgage debt obligation covers not only the repayment of the loan. It includes other factors such as:-
· Peril or fire insurance;
· Property tax.
These elements cover the mortgage debt obligation. Accordingly, in managing one’s mortgage obligation due account should be taken in planning effectively for these elements.
Some institutions have a built in premium system to take care of the total mortgage commitment or obligation. In effect customers are charged a rate or premium that covers all three: - the monthly mortgage repayment, the insurance coverage and the property tax.
Since Peril Insurance and Property Taxes are usually paid annually, it is advisable that homeowners should make adequate provisions for these obligations by saving monthly.
Types of Mortgages
The following are some different types of mortgages: -
· Fixed Interest Rate Mortgages (FRM);
· Adjustable Interest Rate Mortgages (ARM)
· Reverse Mortgages
· Interest Only Mortgages
· Graduated Payment Mortgage,
· Negative amortization mortgage
· Balloon payment mortgage etc.
The most common type of mortgages issued in the Eastern Caribbean Currency Union (ECCU) are Fixed Rate Mortgages and Adjustable Rate Mortgages.
Please note that each of the loan types above except for a straight adjustable rate mortgage can have a period of the loan for which a fixed rate may apply. A Balloon Payment mortgage, for example, can have a fixed rate for the term of the loan followed by the ending balloon payment. Terminology may differ from country to country: loans for which the rate is fixed for less than the life of the loan may be called hybrid adjustable rate mortgages (in the United States).
Fixed Interest Rate Mortgages (FRM)
A fixed rate mortgage (FRM) is a mortgage loan where the interest rate on the note remains the same through the term of the loan, as opposed to loans where the interest rate may adjust or "float."
This payment amount is independent of the additional costs on a home sometimes handled in escrow, such as property taxes and property insurance. Consequently, payments made by the borrower may change over time with the changing escrow amount, but the payments handling the principal and interest on the loan will remain the same.
Fixed rate mortgages are characterized by their interest rate (including compounding frequency, amount of loan, and term of the mortgage). With these three values, the calculation of the monthly payment can then be done.
An interest-only loan is a loan in which for a set term the borrower pays only the interest on the principal balance, with the principal balance unchanged. At the end of the interest-only term the borrower may enter an interest-only mortgage, pay the principal, or (with some lenders) convert the loan to a principal and interest payment (or amortized) loan at his/her option.
A graduated payment mortgage loan, often referred to as GPM, is a mortgage with low initial monthly payments which gradually increase over a specified time frame. These plans are mostly geared towards young men and women who cannot afford large payments now, but can realistically expect to do better financially in the future. For instance a medical student who is just about to finish medical school might not have the financial capability to pay for a mortgage loan, but once he graduates, it is more than probable that he will be earning a high income. It is a form of negative amortization loan
An adjustable rate mortgage (ARM), variable rate mortgage or floating rate mortgage is a mortgage loan where the interest rate on the note is periodically adjusted based on an index. This is done to ensure a steady margin for the lender, whose own cost of funding will usually be related to the index. Consequently, payments made by the borrower may change over time with the changing interest rate (alternatively, the term of the loan may change). This is not to be confused with the graduated payment mortgage which offers changing payment amounts but a fixed interest rate. Other forms of mortgage loan include interest only mortgage, fixed rate mortgage, negative amortization mortgage, and balloon payment mortgage. Adjustable rates transfer part of the interest rate risk from the lender to the borrower. They can be used where unpredictable interest rates make fixed rate loans difficult to obtain. The borrower benefits if the interest rate falls and loses out if interest rates rise.
Adjustable rate mortgages are characterized by their index and limitations on charges (caps). In many countries, adjustable rate mortgages are the norm, and in such places, may simply be referred to as mortgages.
In finance, negative amortization is an amortization method in which the borrower pays back less than the full amount of interest owed to the lender each month. The shorted amount is then added to the total amount owed to the lender. Such a practice would have to be agreed upon before shorting the payment so as to avoid default on payment. Also known as deferred interest or Graduated Payment Mortgage (GPM).
A balloon payment mortgage is a mortgage which does not fully amortize over the term of the note, thus leaving a balance due at maturity. The final payment is called a balloon payment because of its large size. Balloon payment mortgages are more common in commercial real estate than in residential real estate. A balloon payment mortgage may have a fixed or a floating interest rate.
An example of a balloon payment mortgage is the 7-year Fannie Mae Balloon, which features monthly payments based on a 30-year amortization. In the United States, the amount of the balloon payment must be stated in the contract if Truth-in-Lending provisions apply to the loan.
Because borrowers may not have the resources to make the balloon payment at the end of the loan term, a "two-step" mortgage plan may be used with balloon payment mortgages. Under the two-step plan, sometimes referred to as "reset option", the mortgage note "resets" using current market rates and using a fully-amortizing payment schedule. This option is not necessarily automatic, and may only be available if the borrower is still the owner/occupant, has no 30-day late payments in the preceding 12 months, and has no other liens against the property. For balloon payment mortgages without a reset option or where the reset option is not available, the expectation is that either the borrower will have sold the property or refinanced the loan by the end of the loan term. This may mean that there is a refinancing risk.
Adjustable rate mortgages are sometimes confused with balloon payment mortgages. The distinction is that a balloon payment may require refinancing or repayment at the end of the period; some adjustable rate mortgages do not need to be refinanced, and the interest rate is automatically adjusted at the end of the applicable period. Some countries do not allow balloon payment mortgages for residential housing: the lender must continue the loan (the reset option is required). To the borrower, therefore, there is no risk that the lender will refuse to refinance or continue the loan.
A reverse mortgage (known as lifetime mortgage in the United Kingdom) is a loan available to seniors (62 and over in the United States), and is used to release the home equity in the property as one lump or multiple payments. The homeowner's obligation to repay the loan is deferred until the owner dies, the home is sold, or the owner leaves (i.e. into aged care).
In a typical mortgage the homeowner makes a monthly amortized payment to the lender; after each payment the equity increases within his or her property, and typically after 30 years the mortgage is paid in full and the property is released from the lender. In a reverse mortgage, the homeowner makes no payments and all interest is added to the lien on the property. If the owner receives monthly payments, then the debt on the property increases each month.
If a property has increased in value after a reverse mortgage is taken out, it is possible to acquire a second (or third) reverse mortgage over the increased equity in the home. But in certain countries (including the United States), a reverse mortgage must be the first and only mortgage on the property.