BASIC CONCEPT OF HOME LOAN
A home loan or a mortgage can be simply described as the money taken out in order to purchase a home. Now we are going to discuss some basic concepts of a home loan or a mortgage so that the first time home buyer can have a clear idea about the terms and conditions of a mortgage loan.
Mortgage is a kind of loan, which is secured by real property through the presence of legal documents, which evidence the existence of the loan. Very few individuals have enough cash to purchase a home. So, most of the people prefer to take out mortgage loans for financing their homes.
Two basic types of mortgage loans are Fixed Rate Mortgage (FRM) and Adjustable Rate Mortgage (ARM).
Fixed rate mortgage (FRM):
In case of an FRM, the rate of interest remains fixed for the life or the term of the loan. Usually, the term stretches from 15 to 30 years.
Adjustable rate mortgage (ARM):
In an ARM, the interest rate remains fixed for a certain time span. Then, the interest gets adjusted according to the market indices.
There are some other classifications of a mortgage loan, such as, balloon mortgage, home equity loan, jumbo mortgage, reverse mortgage, etc.
It is a kind of mortgage that does not fully amortize over the term of the loan. So, a balance remains due at the maturity. The final payment is called balloon payment. Sometimes, the balloon payment and ARM create confusion. However, the distinction can be made like this – the balloon payment may require refinancing but ARM usually doesn’t require to be refinanced.
Equity loan is a mortgage involving real assets with the objective to provide financial support to the borrower. The interest rate on an equity loan is much lower than that of an unsecured loan.
Jumbo mortgage is a loan involving a huge amount above the industry standard definition of conventional conforming loan limit. The standard is set by two largest secondary market lenders, namely, Fannie Mae (FNMA) and Freddie Mac (FHLMC).
Reverse mortgage is a kind of home loan, which is available to the senior citizens. The home owner’s obligation regarding the repayment of a loan is deferred until his or her death or the property is sold or the owner moves out of the home. In case of a conventional mortgage, the home owner pays monthly installments to the lender and thus the equity increases in the property. In case of a reverse mortgage, the owner does not have to pay any monthly installment to the lender and the interests get added to the lien of the property.
There are some related issues regarding a home loan or a mortgage, such as points and PMI. A point generally means 1% of the total loan amount. For example, if the loan amount is of $1, 00,000, then a point will be $1,000.
Another related issue regarding a mortgage loan is mortgage insurance. So, the question arises, what is mortgage insurance?
Mortgage insurance is the cover to a lender against the loss, which may occur when a borrower defaults on a mortgage loan. Mortgage insurance can be a public or a private policy depending upon the insurer. Mortgage insurance is necessary if the borrower makes less than 20% down payment on a home.
Benefits of mortgage insurance:
- Mortgage insurance provides coverage against loan default.
- Mortgage insurance reduces the possibility of loss due to default.
- It encourages the borrower to buy home with less than 20% down payment.
- Lender is able to share the possible loss with the insurer.
Classifications of mortgage insurance:
Mortgage insurance can be classified as –
Private Mortgage Insurance (PMI):
It is an insurance policy, which reduces the loss that may arise due to the default in repayment of home loan. So, it provides a protection to the lender and encourages the buyer to purchase a home with less than 20% down payment.
Mortgage Life Insurance (MLI):
This is an insurance designed in such a way that the repayment of loan is assured even if the borrower becomes disabled or passes away.