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What Is a Mortgage Loan?

In simple terms, a mortgage loan is a loan made to an individual or group of individuals secured by a piece of property. The property itself is held as collateral or security ("the mortgage") for the repayment of the loan.

A mortgage loan can either be a loan of money for a purchase, such as a loan obtained when a home is bought, or a loan of money for a non-purchase, such as a refinance of an existing mortgage loan. The remainder of this discussion will be about loans of money for a purchase. Refinancing will be discussed later.

When a borrower obtains a mortgage loan, he or she borrows the amount of money required to pay for the property. This is the principal, the amount of money actually being borrowed. Money is loaned for a mortgage at a particular interest rate—interest is what the lender charges you to use the money being borrowed. Payment of the interest is spread out over the life of the loan such that at the end of the loan term, the full amount of principal and interest has been paid.

Other charges may be spread out over the life of the mortgage or over specific portions of it, such as taxes and insurance for the property or private mortgage insurance (PMI) for loans of more than 80% of the property’s value. Taxes and insurance may be included in mortgage payments as a service to the borrower, who may wish to make monthly payments for those expenses rather than semi-annual or annual payments, or as a safeguard for a lender to make sure that taxes and insurance payments are current.

Private mortgage insurance (PMI) is charged by most lenders for loans of more than 80% of the property’s value. This is insurance for the lender in case the borrower defaults on the mortgage. PMI can be canceled when the mortgage balance dips below the 80% value mark.

Mortgages come in a variety of flavors. Loan terms can be anywhere from 10 to 30 years, though the most common is either a 15- or 30-year loan. The most typical loan types are fixed rate, adjustable rate (ARM), or convertible.

	A fixed rate mortgage is a loan with an interest rate that remains the same for the entire term of the loan. Fixed rate loans are recommended if you are planning to keep your home for many years and you expect overall interest rates to increase or remain stable.
	An adjustable rate mortgage (ARM) is a loan with an interest rate that adjusts periodically to reflect changes in a specified financial index. These loans generally have the lowest initial rate and payment. They are recommended if you plan to keep the loan for a short time (less than three years), expect your income to increase substantially, or expect rates to decrease. You may qualify for a larger loan amount with an ARM than you would with a fixed rate mortgage.
	A convertible rate mortgage is a combination of a fixed rate and an adjustable rate loan. It usually has a fixed rate for the first few years and then converts to an adjustable rate for the remainder of the loan term. The starting rate is usually higher than an adjustable rate loan but lower than a fixed rate loan.

A first mortgage or “first” is the primary mortgage on a property that has priority over any and all other mortgages. A second mortgage or “second” is the secondary mortgage on a property with priority over any and all other mortgages, except for the first mortgage. Typically a property will have only a first and possibly a second mortgage placed on it, but there can be as many mortgages on a piece of property as a lender will give.

How Do I Get a Mortgage Loan? Where Do I Begin?

The time to shop for a mortgage loan in order to buy a home is before you’ve fallen in love with a house and made an offer—and before you’re faced with needing proof of loan prequalification to open escrow. If you haven’t done any of these things, you’re ahead of the game. If you’re someone who has already started the process, read on and we’ll get you up to speed and get you what you need!

The very first step in the home or mortgage shopping process is to determine how much house you can afford. There are two aspects to this number: one, how much of a monthly payment you can afford to make, and two, how much cash you have available to make a down payment. You can easily make the first assessment by using a simple online calculator that will help you determine your debt-to-income ratio. In other words, you’ll figure out how your monthly obligations (debts) compare to your monthly income and therefore how much you have available per month to spend on a mortgage.

The second assessment (down payment amount) is something you will determine yourself. We offer another calculator that will help you understand how the size (or percentage) of your down payment will affect your total loan amount, interest rates, and payments over the life of the mortgage.

Once you know how much you can afford to spend on a house, you can do two things: shop for a house and get prequalified for a mortgage. A multitude of resources exist to aid you in searching for a house both online and in person. We suggest a few in particular in our Home Loan Resource Center.

To prequalify for a mortgage and to receive loan rate offers, simply answer a few short questions in our Loan Application, and we’ll contact you to tell you if you’re prequalified for a loan, show you a list of loan options with rates and terms, give you the option to receive out a Prequalification Letter, and take you through the rest of the application process should you wish to accept a loan program.

Once you have found a house you wish to purchase and selected a loan offer you wish to take, submit the required documentation, and we will secure a mortgage for your home. We will work with your real estate broker and the title or escrow company to coordinate the escrow and funding of your loan.

Should I Rent or Buy?

The decision of whether to rent or buy a place to live is fundamentally a personal choice—will you be comfortable with the financial and personal responsibility? Many people don’t ever buy property, preferring the freedom of choice and mobility and the freedom from responsibility for upkeep. Other individuals thrive on owning property. They enjoy the upkeep and responsibility and see real estate as one of the most secure and high-yield investments available.

The “truth” of home ownership is probably different for everyone. One person’s huge gain may be another person’s huge loss or someone else’s average result. Like any investment, real estate entails some risk. However, as with other investment types, you can perform research to fully understand the ground rules, you can carefully evaluate your own wants and preferences, and you can make an informed decision.

If you’re trying to decide whether or not to buy a house, consider the following questions:

	Can you afford the monthly payment? A mortgage payment will probably be higher than a rent payment. You’ll need to determine if you can pay the additional money per month, and, in addition, if you can afford the monthly or annual costs of insurance, property taxes, and general upkeep. Furthermore, you should be sure that you’ll be able to continue to make that payment for years to come—that your job and anticipated salary will continue to support the payment.
	How long do you plan to live in the area? The rule of thumb is that you shouldn’t buy a house if you don’t plan to own it for at least three to five years. Buying, selling, and mortgaging a house can incur significant fees, and three to five years is typically a break-even point for recouping those fees. If you plan to make a major move in the next few years, buying now may not be in your best interest.
	Can you qualify for a mortgage? You will probably need to make some amount of down payment when purchasing a house, so you’ll need to figure out how much cash you have on hand or available from other investments. You’ll also need to think about your credit history and income in order to secure a mortgage. Mortgage lenders will usually want to see income documentation for the last two years to determine a consistent level of income. They will also examine your resources, for the down payment, and your credit history, for your record of credit and credit repayment.
	Do you plan any major life changes (e.g., radical employment changes, marriage, children) in the very near future? Be sure to consider any other impending life changes in your calculations of resource needs or future ability to pay. You may be planning to have children soon; if so, you may incur additional costs that you’ll need to budget for. You may be planning to change careers or return to school, either of which could mean a change in your financial status.
	How are interest rates and the housing market? Though you can’t control area home values and interest rates, you can look at trends and past industry behavior. Are rates at or near an all-time low? A relative high? Are home prices increasing or decreasing? To some extent, you will have to make a guess as to how these numbers will behave in the future, but examining trends will help you educate yourself in order to make a more informed decision.
	Will it give me any tax savings to own a home? Depending upon your income, tax bracket, property value, and amount of interest payments, owning a home could be a huge tax advantage.

One advantage to purchasing a house and securing a mortgage is that someday you may not have to make a monthly payment for a place to live. Real estate also can be a tremendous investment vehicle, especially if property values increase at a higher rate than your mortgage interest. However, home ownership may not be for everyone. You may be in a situation where your rent is so low that it just doesn’t make any financial sense for you to buy a house. That’s fine. Ultimately the decision to buy a house has to make sense for you, on both a personal and financial level.

Why, and When, Should I Refinance?

There are about as many reasons to refinance a home mortgage as there are borrowers. You may want to refinance if you can get yourself a better deal—but remember, “a better deal” may mean different things to different people.

The most common reason for refinancing a mortgage is to improve monthly payments, whether you want a lower interest rate, a lower monthly payment, or a different loan type or length. Also, borrowers may wish to take cash out of their home in addition to improving their mortgage terms—you may need cash for anything from a new car to home improvements to consolidation of debts.

If you refinance your mortgage and keep all other terms and conditions the same, here’s what different loan terms may do for you:

	A lower interest rate usually means you pay less monthly interest as part of your monthly payment.
	A lower monthly payment will mean less cash out of your pocket per month; it may also mean a longer loan term.
	A shorter loan term or length will probably mean higher monthly payments, but a faster total repayment time. This reduces the total interest you pay over the life of the loan.
	A longer loan term or length will probably mean lower monthly payments, but a longer total repayment time. This increases the total interest you pay over the life of the loan.
	A different loan type (e.g., fixed, ARM, or convertible) will mean either a fixed interest rate over the life of your loan and a monthly payment amount that never changes or a variable interest rate, whose rate and monthly payment will change at set periods during the life of the loan, but which usually offers a lower start rate and payment.

Another good question to ask is if you can consolidate debts at a lower overall interest rate. If you’ve got a $20,000 auto loan at 10% and $10,000 in credit card debt at 15%, you may well be paying out less per month—and over the long term—if you refinance your house for $30,000 more than your current mortgage total in order to pay off the other debts. This applies even if your refinanced mortgage rate is slightly higher than your current rate.

When considering whether or not to refinance you’ll want to take into account your personal financial situation, including other debts and expectations, as well as interest rate and property value trends. The situation and needs of every borrower are unique; what works for you may not work for your neighbor. Careful consideration of your options and needs, however, will assure you make the best decision for your personal situation.

Should I Avoid PMI?

Private Mortgage Insurance (PMI) is intended to make homeownership possible for people who want to buy a home but who can’t afford a 20% down payment. It is insurance required on loans that cover more than 80% of the home’s value, in order to protect the lender from possible default on the loan. A fee is charged by the insurance company for the mortgage insurance, which must be paid in addition to the principal and interest on a loan. Once the loan-to-value ratio of the property is below 80%, however, either through paying down the loan or through the appreciation of the property, PMI can be canceled.

In response to consumer demand for low down payment loans with as few fees as possible, lenders have begun to offer alternatives to PMI: two mortgages. This usually occurs in the combination of an 80% first mortgage, a 10% second mortgage, and a 10% down payment; but variations also occur, such as a 75% first, a 20% second, and 5% down.

Borrowers should discuss carefully with their lenders or brokers what the monthly and long-term costs are for PMI and non-PMI options. The smaller, second mortgages usually carry a shorter term (e.g., 15 years) and a higher interest rate than the first mortgage, and thus may increase the borrower’s monthly outlay. However, paying for PMI will also mean an increase in monthly payments.

You should keep in mind two considerations about PMI and second mortgages. First, PMI is a fee being charged on the entire amount of the home loan—which may, in the long run, be a larger dollar amount than the second mortgage amount. Second, interest paid on a second mortgage may be tax-deductible—PMI is not.

Let’s examine the costs of PMI. As an example, let’s say a borrower takes out a loan that is 90% of the value of the home, or 90% loan-to-value, and is charged 0.25% for PMI. For that extra 10% above the 80% PMI threshold, the borrower is paying an extra 0.25% on all 90%. In the final calculation, the extra 10% is costing the borrower a full 2.25% more over the life of the loan. A borrower who plans to own his or her home for a longer period of time (generally 5-7 years or more) may find paying a slightly higher percentage for a second mortgage more palatable than paying PMI.

A good counterexample is a borrower who may only plan to own his or her home for a very short term—perhaps only a year or two. Because the monthly payment for PMI is likely to be less than a payment on a second mortgage, the borrower will have more funds available on a monthly basis to pay for improvements or other investments. He or she will still have paid less over the year or two of ownership by paying PMI rather than paying a second mortgage.

There is no single answer to the PMI question. What this means is that you should work with your loan officer or broker to determine whether paying PMI will best suit your needs. You may not have much cash for a down payment, but can make a substantial monthly payment; you may feel that the property will appreciate rapidly, which might allow you to cancel PMI in a year or two; or you might plan to stay in the property for 15 years or more, in which case you may be looking for the lowest costs over the long term. Your loan officer will be able to help you evaluate which option will best suit your needs and your unique situation.