Home
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.
.
Balloon mortgage:
.
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:
.
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:
.
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:
.
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.