Finance for Morons: What’s a Mortgage?

A mortgage is a loan used to purchase a house.
There are several ways to get a mortgage. The “old fashioned” way is through a bank or a “home savings and loan” company. The more contemporary way is through a “mortgage broker” which is a company that sells mortgages for a mortgage company like Countrywide.

The recent housing collapse has discredited the mortgage broker business. Thousands of businesses related to this sector have failed. So we’re back to the “old-fashioned” mortgages.

What makes a mortgage different from a personal loan or a credit card loan is that the property being purchased is the “collateral” for the loan.

Collateral is a “guarantee for a loan” in case you can’t pay it. If you stop making the monthly payment, the lender will take the property. This is called “defaulting” on loan.

(Right now, the value of the property is declining, so, when people default, the bank is left owning a property that won’t cover the mortgage. That’s why banks are failing – the loans they made are turning into money-losers. With such a huge potential loss, the banks are willing to renegotiate, and settle for less profit so you can keep paying off the loan.)

When a house is being foreclosed, people will often say “the bank is taking away my house.” This isn’t true. Until the mortgage is paid off, the bank practically owns your house. You just get to stay in it while you pay off the large loan.

It beats renting if you don’t have many repairs to make.

There are different kinds of mortgages, but the two main categories are “fixed rate” and “adjustable rate.” The fixed rate mortgage retains the same interest rate until the loan is paid off. The adjustable-rate mortgage has an interest rate that can drop or rise.

When interest rates are low, it’s best to lock in a low rate. The bank will give you the low rate only if you have great credit – that’s because they’re competing for your business. When you’re a reliable borrower, everyone wants to lend to you.

When interest rates are high, it’s best to get the variable rate mortgage. The interest rate is likely to drop. Again, they will do this to discourage you from refinancing.

(Refinancing is the process of getting a new mortgage. The first mortgage is paid off with the new mortgage, which has a better interest rate or different terms than the first mortgage.)

Of course, if you have bad credit, they will try to keep you at a fixed rate, high-interest mortgage. You’ll need to refinance later when interest rates drop.

This all seems unfair, but, it’s all pretty consistent with the goal of banks, which is to make a profit by lending money. If you want to avoid these hassles, try to save money into a savings account, consistently, so you won’t need to borrow so much money.

There’s a lot more to mortgages, and you can search the web for a lot more information.