Dear Ney Ney,
If you want to buy a house, or any type of real estate, you will likely need a mortgage. A mortgage is a loan to buy real estate. The process for getting a mortgage depends in part on if you are buying a residential or commercial property. There are other differences between residential and commercial loans.
Most residential mortgages have three big factors. The first is the term, or length of the loan. The second is the interest rate charged by the bank on the loans. The third is how much of the purchase does the bank want you to pay for in cash, called a down payment.
Most residential loans last for 30 years. Another common term is 15 years, but this is less popular because the monthly mortgage payments are higher. Some banks will offer 25, 20, or 10 year mortgages. These are much less common for residential real estate.
The interest rate is the fee you pay to the bank for giving you the loan. This is given as a percentage. Interest is due on the amount of the loan that remains each month, which is called the principle or loan balance. Mortgages are designed so that each payment includes the interest due and then an additional amount to pay down the principle. As you make each payment, the principle reduces, so more of each payment goes towards the principle of the loan.
The interest rate a bank changes depending on the health of the economy. The Federal Government plays a role in the interest rate you pay on your mortgage. Part of the government called the Federal Reserve helps banks move money between each other, and when he money is between banks, the government pays interest on it to the banks.
Banks use the Federal Reserve interest rate, called the “Federal Funds Rate,” as the basis for the interest they charge for loans. The government changes the rate to make it less or more expensive to borrow money, both to buy houses or grow a business. This is the main way the government influences the economy.
If you decide to get a mortgage for less than 30 years the interest rate you pay is usually less. The monthly payment will likely be higher because of the shorter loan term, but over the course of the entire loan you will pay much less in interest to the bank than with a 30 year mortgage.
People often decide to get a 30 year mortgage because it is the lowest monthly payment. In this case you can always make extra payments to pay down the principle faster and reduce the total amount of interest paid to the bank.
Down payments vary depending on the bank, the loan type, and the property. Down payments are normally expressed in percentages, such as “20 percent down.” Typically, the more money you put down, the lower interest rate you may pay on the loan.
Loans with down payments less than 20 percent often, but not always, make you pay extra fees each month. These loans make it easier to buy a home because you don’t need to save up a large down payment, but your monthly payment is more expensive.
When you decide that it’s time to buy a property, one of the first steps is usually to talk to a bank to find out how large of a mortgage they will lend to you. This is called getting prequalified for a mortgage. The bank will ask you how much money you make, how much debt you already owe, and what your credit score is. Based on this information the bank will decide if they will lend you money and how much money they will lend you.
After you are under contract on a property you then go back to the bank and apply for the loan. Applying for a loan is similar to getting prequalified, but the bank will want proof of your income, your assets, and your other debts. For example, you might need to get proof of your employment and salary from your employer. You might also need to provide documents from your bank about how much money you have in your bank account.
The bank uses this information to determine your debt to income ratio. The bank added up you income from your job and your investments to get your income. Then the bank adds up the payments on any debt such as other mortgages, car loans, student loans, or credit cards to determine your debt. If your debts are too much more then your income the bank will not give you a mortgage.
The bank will also want to know information about the property. For example, they will want to know how much taxes will be on the property each year, how much it will cost to buy insurance for the property each year, and the value of the property. The bank wants to know that you can afford not just the mortgage payment, but also the taxes and insurance on the property. They also want to know that the property is worth the price that you are paying for it.
In order to determine the value of the property, the bank performs what is called an appraisal of the property. A person who is familiar with looking at houses will visit the property and look at the condition it is in, then compare that property to other homes that recently sold, and determine a value for the property. If the bank appraiser value of the property is less than what you are paying for the property, the bank will ask you to pay the difference as part of your down payment.
The person at the bank who collects the information from you and processes the loan is called a loan officer. Sometimes people refer to loan officers as their “lender,” but the word lender is also sometimes used to refer to the bank giving the loan. Once the loan officer has reviewed and confirmed all of your information they pass the information to another person at the bank called an underwriter.
The underwriter carefully reviews all the work done by the loan officer. This process is called underwriting the loan. Sometimes the underwriter might ask for additional information from you to make a decision about the loan. The underwriter is the final person who approves the loan at the bank.
Once your loan is final approved you agree to it at closing. When you purchase the property the bank asks the government to record a lien against your property. A lien is a government record that you owe someone money for something, such as a house or a car. A lien is a public record, meaning that anyone can see it exists. A lien means you cannot transfer ownership of the property, such as through a sale, without either paying off the lien holder or getting their permission.
Taxes and Insurance and Eacrow
When you talk to people, or a loan officer, about a mortgage you might hear the term PITI. PITI means Principle, Interest, Taxes, and Insurance. Most mortgage payments to the bank include more than just the principle and interest payments. Usually, the bank also collects money to pay for property taxes and home insurance.
Property taxes are the taxes collected by the local government, usually either a city or a county, on land and buildings within the city or county. These taxes help pay for services such as public schools and the police. Property taxes can be very different between two places near each other.
Property taxes are based on what the government thinks, or assesses, your property is worth. Usually, but not always, the government values homes at less than the price at which they sell. However, when you buy a house the government updates the taxes value based on the sales price, so the taxes you pay on the house might be much higher than what is shown in the information provided by the seller’s real estate agent when the house is for sale.
Taxes might also vary depending on how you use the property. If you reside at the property sometimes you pay a lower rate then if you rent the house to a tenant.
Insurance is financial protection from unexpected accidents and disasters. There are many types of insurance. The insurance for a home is called “homeowners insurance.” You buy insurance from an insurance agency, and the fee you pay is called the insurance premium.
Home owners insurance protects you from from accidents that might damage your home such as a fire or a leaky pipe. In the case of a fire that destroys your house, the insurance company will provide you with money to rebuild your homes. In the case of a leaky pipe that damages ceilings and floors, the insurance company will reimburse you for the cost to repair the damage. Some insurance companies even will call a repair company for you and pay them directly.
The mortgage company is listed ion the insurance policy so that the loan balance is paid by the insurance company in case there is so much damage to the house that it cannot be rebuilt or you decide not to rebuild it.
Commercial mortgages versus residential mortgages.
If you want to buy commercial property then you will need a commercial loan. Some of the same ideas as residential mortgages apply, but there are also many differences.
The interest rate on a commercial loan is usually higher than a residential mortgage. People will usually work very hard to pay the mortgage on a home they live in because it is their home. Lending to a company, which views the property as a business and not a home, is more risky because if the business stops making money the business will close and not pay the mortgage.
The down payment is usually around 25%. This is the same even on residential properties that are purchased as investment properties.
The bank usually wants someone involved who has a large amount of money. This is money in addition to the down payment. The amount of money that they want you or a business partner to have varies. If you don’t have the necessary money then you can partner with someone who does to buy the property together.
The loans are usually for a shorter term, between 3 and 20 years. The loans can follow the same payment, or amortization, schedule as a 30 year loan but at the end of the loan term you must pay the loan balance in full. This is called a balloon payment. When it gets close to the end of the term you will refinance, which means get a new loan, if you do not have the money to make the balloon payment.
Mortgages are complicated, so don’t worry if you need to read this a few times to feel like you understand it all. Mortgages are powerful because they let you own an expensive asset for a smaller amount of money. Use that power wisely. You must pay on time and not take on more debt than you or the rents from a property can pay.
I love you.
Dad
