Mortgages Explained

A mortgage is a loan that a borrower obtains for the purchase of real estate. A mortgage is obtained from a financial institution and sometimes even the property seller. The building/s and/or the land purchased by the borrower are the collateral for the loan. If the borrower fails to make the payments stipulated in the contract, the lender can seize the home through a process known as foreclosure.

Mortgages tend to be very large loans and as such, borrowers usually pay them off over long periods, often between 15 and 30 years. With each monthly payment, a mortgage pays interest on the loan, and usually some of the principal, so that gradually over time, the loan is payed off. By spreading the payments over a long period of time, financial institutions make real estate affordable.

The amount of each payment that goes toward interest and principal changes as the loan is paid down. Typically, in the early stages of paying off a mortgage, the payments are mostly interest with very little going toward paying down the principal. As time passes and more payments are made, the percentage that goes toward interest declines and the percentage that goes toward principal increases. By the end of the mortgage, the monthly payment goes almost entirely toward the principal with very little interest being paid. Once the mortgage has been payed off in full, the borrower has full equity in the property.

While this is how a typical mortgage works, known as a repayment mortgage, there is also another type of mortgage called an interest only mortgage. With an interest only mortgage, you only pay the interest on the amount you borrowed, so you will still owe the entire principal of the loan at then end of the mortgage and you’ll need to plan how to pay this off. Interest only mortgages can be a good choice for those who are unable to afford a repayment mortgage, but expect to have more money in the future to pay down the principal.

Once you have decided whether you want an interest only or a repayment mortgage, there are many variations to choose from. Two major types of mortgage are fixed rate and variable or adjustable rate mortgages. With a fixed mortgage rate, the interest rate is set for the entire term of the loan. This means that the monthly payments do not fluctuate, enabling the long-term borrower to budget and plan their finances over the long term.

By contrast, under variable or adjustable-rate mortgages (ARMs), the interest rate will periodically go up or down based on a predetermined index. This means that the borrower’s monthly payment may fluctuate over time. This type of mortgage is more of a gamble, since the borrower will pay more if interest rates rise or less if interest rates fall.

Unlike fixed-rate mortgages, some ARMs give borrowers the opportunity to pay off the principal amount early without penalty. To protect the borrower, there is usually a maximum limit that interest rates can rise in a year or over the term of the mortgage. In addition, borrowers are often offered a fixed interest rate for the initial period of the mortgage before rates start to fluctuate. Since ARMs transfer the risk from the lender to the borrower, lenders often offer very low initial rates, making this type of mortgage attractive to short-term investors.

There are several other types of mortgages available. A negative amortization mortgage enables the borrower to pay back less interest each month than is owed. The interest that is not paid is added to the total that the borrower owes the lender. This is also known as a deferred interest or graduated payment mortgage.

A discounted rate mortgage is one in which the lender offers a discount off its standard variable rate mortgage for a period of time, typically two years. Once the period has elapsed, the rate is reverted to the standard variable rate. This is ideal for young home-owners and first-time buyers who believe that when the discount period ends, they will be able to afford the higher payments.

Another type of mortgage is known as the balloon payment mortgage. Under this type of mortgage, borrowers get lower rates and payments for some time, typically three to ten years. At the end of that time, the borrower has to pay the principal in full, making the final payment much larger than the regular monthly payments. This mortgage is ideal for those who plan on selling, refinancing or selling their home before the balloon payment is due.

Refinancing is paying off your existing mortgage with proceeds from a new mortgage. Refinancing your mortgage is a way of replacing high interest debt with a loan that has a lower interest rate, or to withdraw equity they have built up in their home. Refinancing can also enable you to switch from a fixed to a variable rate mortgage and vice versa.

Understanding Today's Mortgages

How to Avoid Foreclosures and Keep Your Home
You're not alone if you're having trouble paying your mortgage. The housing boom led to a record homeownership rate of nearly 70 percent, but some homeowners now face problems making their mortgage payments and can't refinance their loans. This brochure will help you understand your options and give you tips on how to avoid losing your home — regardless of what kind of mortgage you have. Read more >

How to Avoid Predatory Lending
Finding an affordable home loan with fair terms and reasonable costs is a crucial step towards achieving homeownership. Unfortunately, home buyers need to be aware that some lenders offer predatory loans that take advantage of consumers. This brochure, produced jointly by NAR and the Center for Responsible Lending, identifies the warning signs of predatory loans and offers tips on how to avoid them, including questions they should ask when shopping for a loan. Read more >

Specialty (Nontraditional) Mortgages: What are the Risks and Advantages?
Produced jointly by NAR and the Center for Responsible Lending, this brochure can help prospective buyers make decide on the kind of home financing that is best for them. It will help your clients assess the risks and advantages of interest-only, negative amortization, payment option ARM, and 40-year mortgages. Available in English and Spanish. Read more >

Traditional Mortgages: Understanding Your Options
With the rise of specialty (nontraditional) mortgage options, consumers have more choices than ever before. Although specialty mortgages may help make homeownership more affordable, they generate more risk. Consumers should understand these risks before they choose a mortgage. This brochure, produced jointly by NAR and the Center for Responsible Lending, explains that traditional fixed-rate mortgages and adjustable-rate mortgages (ARMs) continue to be excellent options for most consumers. Read more >

Learn About FHA Mortgages
The Federal Housing Administration has made significant improvements to its mortgage insurance programs. Many aspects of the FHA application process have been streamlined to be more user-friendly and efficient. This brochure, produced by NAR, the FHA, and the U.S. Department of Housing and Urban Development, outlines changes to FHA, how to qualify for an FHA mortgage, and other resources available from FHA, HUD, and NAR. Read more

The Art of Negotiation

Real Estate is one of the few places (along with the automobile business) in American life where some form of negotiation is the rule rather than the exception. Just because it is the norm, however, does not mean that most people are proficient at it. Sure, most folks feel that they are the best negotiators in the world, but in reality, it is a learned art. It takes a keen understanding of the process in order to be good at it--and before you begin making offers on homes.

When it comes to Real Estate matters, the 3 most important aspects of an effective negotiation are:

Recognizing that being a good negotiator does not come naturally to most people--it must be worked at--is the first step in becoming one.

Information
CMA's--Comparable Market Analyses

Once you have found a home that you are prepared to buy, the first step in your process of negotiation is to determine the fair value for the home. Your Agent can be of great help here, since Real Estate Agents have access to the information that you need: Comparable Market Analyses (CMAs). A CMA will show exactly what properties similar to the one in which you have an interest have sold for. These analyses are based on fact, rather than opinion, and that information will always be of more value to you. Generally, CMAs will list houses in a particular location that are currently on the market, have sales pending on them, have expired from the market, and have sold. Be forewarned: it is primarily the SOLD properties that you need to be concerned with. What houses are on the market for is not always a good indication of what their value is, those that have pending sales will only tell you what the listing price is (not what it is going to sell for) and those that have expired because they haven't sold may indicate that they didn't move because they were overpriced.

The CMA which you obtain will most likely give you some general information about the houses that will be compared: Number of bedrooms and baths, square footage, the listing price and the sold price. It is important that the CMA focuses on houses similar to the one you have selected. If you are interested in a 4 bedroom, 2 1/2 bath 2 story, a CMA that lists only 3 bedroom 1 bath homes is of little or no value. Likewise, a CMA that includes a number of properties from a neighborhood 2 miles away will have limited value. To have a good CMA you must have all of the similar sales in the neighborhood in the last year. Obviously, the fresher the data (the more houses sold in the last few months), the better the CMA.

Note: In all likelihood, if you are dealing with the Selling Agent instead of a Buyer's Agent, you will not have access to a CMA. This is one of the many reasons that it is vitally important to consider Buyer's Representation.

Condition

Once you have the information in hand, it is important to drive by all of the properties that are listed in the SOLD column. Why? Because condition has so much to do with the ultimate selling price of a house. Does the home in which you are interested shine above or fall below the others that have sold. Size, number of rooms, and lot size can only tell you so much. Your eyes will be able to tell you a lot more. Make a realistic comparison between the condition of your chosen house and those that have recently sold. Then adjust your thinking up or down from what you have seen.

Extra Amenities

Does the house you have chosen have more or less amenities than the comparable homes? Although amenities will not affect the value as much as location or condition will, they still can be a factor. Be wary, though. An outdoor hot tub may have been a major motivating factor in your choice of a house, but it will not add a great deal to the value of the property.

Motivation

An effective negotiator will gather as much information as is available on the house and the sellers. Obviously, one of the most important pieces of information you can have is the seller's reason for selling. Is it a case of having to sell or wanting to sell? Or, is it a case of "lets throw it on the market at a goofy price, and if somebody bites, we'll move?" If your Agent represents you in the transaction as a Buyer's Agent, they may or may not be able to secure this information for you (it depends on what the seller and the Seller's Agent want to reveal). If you are working with an Agent that represents the seller in the transaction (or in a Dual Agency position) they cannot disclose this information without the seller's consent. Even if this information cannot be revealed to you, a friendly discussion with one of the neighbors may give you a feel for the situation.

Preparation

Just having the right information is not enough. You must prepare yourself in order to use it effectively. The most important factor in your preparation is your emotional frame of mind. Buying a house is emotionally charged enough, without adding more fuel to the fire by letting your emotions override your common sense. It is not unusual to be excited--in fact, it is normal--but you must keep your excitement in check or you will lose the value of all the information you have gathered.

In addition to your emotional frame of mind, your financial frame of mind should be in order. An offer to purchase will carry a lot more weight if there are no dangling financial problems and if you have been pre-qualified for a mortgage.

"You can't be afraid to let it go." You must convince yourself that if the price is not to your liking (or worse, above your budget), you will be able to walk away. It is important for you to set a realistic limit and then stick to it. Overpaying for a house is epidemic among buyers who let their emotions rule their better judgment. It becomes very easy to regret paying too much for a house when you make a mortgage payment every month. Unlike a product that you overpay for once when you buy it, a house reminds you every 30 days that you made a mistake!

Finally, plan your work and work your plan. Organize your information and have it quickly available. When it comes time to make an offer, you don't want your "ammunition" scattered on scraps of paper in the back seat of your car. Again, familiarize yourself with offers and contracts, since this is how you will be negotiating.

Realism

Don't throw away all of the information gathering and preparation you have done by making a ridiculous offer on a well priced home. Nothing will turn a seller off more than a low ball offer on a house that has been realistically priced. Often, negotiations will stop, rarely to be revived again. If they are re-opened, the sellers generally will show their displeasure at the initial low offer by locking at or near the listing price.

An example: Mr. and Mrs. Buyer have been looking at houses for months. Finally, they find the perfect house, which is an ideal match for their needs and wants. The house is listed at $155,000. Mr. and Mrs. Buyer have a CMA in hand that shows average selling prices in the neighborhood to be in the $148,000 to $153,000 range. Ignoring the information they have, they make an offer of $120,000. Mr. and Mrs. Seller, annoyed at the low offer, counter offer at full selling price, $155,000. The Buyers, still convinced that they can "steal" this house, make a 2nd offer of $125,000. The Sellers, now very frustrated, do not move from their $155,000 price. Suddenly, there is word that another offer is forthcoming, this time from Mr. and Mrs. Smith. In fear of losing the house, Mr. and Mrs. Buyer up their offer to $154,000 (still needing some concession) and the Sellers accept. Consider, though, that a realistic first offer in the $150,000 range (remember, the CMA showed $148,000 to $153,000) may well have been accepted by the Sellers. If this were the case, the Buyer's paid $4000 more than they had to.

The moral: An unrealistic offer on a house that meets your needs and is priced correctly could end up costing more than it would with a realistic offer.