What the Finance is a Mortgage? A mortgage is a word that actually means Death Pledge! It is an old French term that indicates the obligation would be dead once paid off or if the property was foreclosed on.

A mortgage is an obligation in which the lender will lend you a large amount of money with the property acting as security for the loan. This means that IF you do not follow through on the required mortgage payments, the lender can take the property through a process called foreclosure.

The most common type of mortgage out there is a 30 year fixed rate mortgage. The 30 years is the term of the mortgage and the FIXED-RATE means that the interest rate will NOT change over those 30 years. It means the monthly payment of principal and interest will also not change. There are other variations of the fixed-rate mortgage based on the term, including the 15 year fixed-rate mortgage which is also popular.

Another type of mortgage is known as the Adjustable Rate Mortgage (ARM). The adjustable rate mortgage is different than the fixed-rate mortgage in that the interest rate is not fixed and can adjust in the future based on market conditions. The ARM mortgage interest rate is based on a margin and an index which add together to get the total interest rate. The most common index for an ARM mortgage is the London Interbank Offering Rate also called the LIBOR. The LIBOR index can adjust but the margin is fixed. The ARM mortgage is generally considered to be more risky because if interest rates rise in the future that will increase your mortgage payment.

Two other types of mortgages that are not as popular anymore are the Interest Only Mortgage and the Balloon Mortgage. The interest only mortgage allows you to pay ONLY the monthly interest each month for a certain amount of years, usually 5-10 years, and then you have to pay both principal and interest for the remainder of the term. This can lease to payment shock because the principal and interest payment would be much higher than the interest only payment and is very risky compared to fixed-rate mortgages. The balloon mortgage is unique in that the mortgage is calculated, from a monthly payment basis, to be paid off in 30 years, but is considered DUE sooner than that, say in 10-15 years, which you would have a balance due that would need to be paid for in full on that date.

The process to get a home loan is much more complex now in 2019 than it was in the past with many more regulation to protect consumers. Lenders look at 4 main considerations when qualifying a loan applicant: CREDIT, CAPACITY, COLLATERAL and ASSETS.

CREDIT refers to your credit repayment history. How have you repaid your obligations/debt in the past. Are you somebody who always pays everything on time and in full or do you have a history of missing payments, being late on payments, or failing to pay altogether?

CAPACITY refers to your ability to re-pay the mortgage and lenders will look at your monthly income and your existing monthly obligations and calculate the monthly debt to income ratio. They will include the new mortgage payment, property taxes, homeowners insurance for the property as well as any existing obligations such as car loans, credit card. Monthly payments, student loans, etc. Their goal is to confirm that you will be able to AFFORD this monthly mortgage payment. Generally, the maximum debt to income ratio, calculated by taking monthly debt divided by monthly income, is 43% or 0.43.

COLLATERAL stands for the property backing up the loan. Lenders want to know that both the VALUE of the property and the CONDITION of the property is sufficient. IF the lender has to take over their property and sell it to recoup their investment, they want to make sure it doesn’t have any major issues and is worth enough to cover their investment.

From an ASSET perspective, and depending on the mortgage product, the lender will definitely want to confirm you have sufficient money for the down payment, but also to know it is your money as opposed to a loan. They may also want you to show sufficient reserves of 2 months to confirm you have a cash cushion in your account.

Ultimately though, you want to know what type of mortgage is RIGHT FOR YOU. I definitely recommend a 15 year or 30 year mortgage for most people. The FIXED payment and FIXED interest rate helps lock in the obligation. If you have a lot more disposable income each month, you can consider an ARM mortgage or even a balloon or interest only mortgage, but those definitely carry more risk.

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My name is JOE and I am just your AVERAGE JOE ON MONEY. This channel talks about ALL THINGS personal finance that help people like YOU and I, the Average Joe, learn the fundamental principles of money and win with our finances.


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