How Does a Mortgage Work?

10:00 AM March 17, 2020

How does a mortgage work? A mortgage can be a very alarming word if you don’t know the answer that question. The words that come to mind are debt, expensive, monthly, and, for most people, scary.

There are some positive words that come to mind as well, such as ownership, equity, and net worth.

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One key thing to remember is that owning a house can be much better than renting one.

Understanding how does a mortgage works and why owning real estate is a pro instead of a con is essential in today’s economy.

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Owning vs. Renting

renting vs owning a house

While renting a house or an apartment, you are literally paying for someone else’s mortgage.

They bought the house and you are paying it for them. They might even be making some additional money by having you pay more than their mortgage payment.

While renting, your money goes to them and does not help you out in the long run. While purchasing a home, your money will go towards your mortgage.

This decreases the loan balance and increases your equity in the home, which, in turn, increases your net worth.

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This is very important to understand and we want you to understand them through and through.

Mortgages can be a scary debt to have.

The pros will outweigh the cons of most days.

Purchasing a Home
home purchase

There are going to be a few different sections to discuss in order to understand these properly.

The majority of people need to have a home loan in order to have their own house.

They are expensive and can cost you a significant amount of capital.

Understanding what loan program (or type of mortgage) to use is vital.

Two of the most popular mortgages are conventional loans and FHA loans.

FHA loans are important to understand because they are the best for a low downpayment, low credit scores, and for first-time homebuyers.

With how expensive homes can be, this may be a beneficial option.

How to Choose a Mortgage Lender

Mortgage lenders are banks that specifically handle home purchases.

They are the ones that will approve or deny you, for a certain dollar amount.

If they consider you a “high risk” applicant, they may give you a higher interest rate. Otherwise, they may just end up denying you the ability to receive a loan from them altogether.

The higher the interest rate, the larger the balance you will be paying.

Take a look at this debt calculator to calculate how much you will spend in total.

Once approved, they will provide an opportunity to take advantage of a 30-year fixed-rate mortgage.

Then you have the chance to buy the home – with their approval of course.

Loan Type

types of loans

Odds are they will be giving you a fixed-rate mortgage where the interest rate will be staying the same for all 30 years.

There is also an option to have an interest-only mortgage, which benefits first-time homebuyers.

This type of loan means you will not be paying any payment to go towards the principal. You will just be paying it towards the interest.

This may be a tough decision to make between interest-only and principal plus interest.

Everyone has a different financial situation. Once you have selected your lender, ask them as many questions as needed until you fully understand the answer to this vital question: how does a mortgage work?

This is a great topic for you and your mortgage lender to discuss.

They should make sure that your needs come first and that you get what works best for you.

How Does a House Loan Work

house loans

Understanding how a mortgage works may be one of the most important parts of buying a home.

This is what you personally have to focus on for the next 30 years of your life.

Making sure you are able to afford the house can be an entirely different topic.

Just because you get approved for the loan does not mean that you should buy the home.

Monthly mortgage payments are paid towards the home.

These payments are going towards the balance of the home plus the interest.

This is also known as principal and interest.

Look at the amortization calculator to understand how this works.

The home will have a purchase price, which is what you and the person that is going to sell the home will discuss and negotiate.

This amount that is agreed upon will then be taken to the mortgage lender to get approved.

The buyer will have a down payment, just like with a car loan.

The majority of the time it is about 20% of the purchase price.

For example: A $300,000 home that has a 20% down payment will total $60,000. ($300,000 x 20% = $60,0000)

Using the example above, the loan amount will then be $260,000. ($300,000 – $60,000 = $260,000)

This is the amount that is going to be used to calculate the monthly payment.

They will use that dollar amount and the interest rate to figure out exactly how much the payment will be.

Using the example above, after 5 years you have paid $10,000 towards the principal.

If you take the loan amount and subtract how much you have paid that goes towards the principal amount, you get the loan balance.

Using the example above, this is the calculation for the loan balance. ($260,000 – $10,000 = $250,000)

The main benefit of owning a house is owning equity of your real estate property.

The portion that you own will help you in the long run.

You may have to sell your home eventually.

If you have a 50% equity, then you have $150,000 already, plus any additional funds you may have in your bank account.

These funds could be used to go towards your next house.

SUMMARY

The benefits of owning a house are far more significant than renting a home. Now that you have a better understanding of the answer to the question, “How does a mortgage work?”

You are ready to start the exciting process of home buying. Selling a lease is not worth anything.

If you live in a house that you rent for 20 years – you own nothing.

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