Mortgages are a crucial part of the decision-making process when buying a house. If you’re like most people, your home will be your biggest purchase and a most major asset. Mortgages can be a tricky subject and not something we all know too much about.
That is why we have created this blog post to guide you through the process and help you understand how mortgages work. So keep on reading to find out more about mortgages and how they can help you buy a house.
What is a mortgage?
When you purchase a house, your mortgage is the loan you take out from a bank or lender to pay for the property. Mortgages are a trendy way of buying a property because they allow you to make a large purchase without spending too much money upfront.
Instead, a lender will give you a certain amount of money that must be paid back over time with interest added.
Mortgages are one of the oldest types of loans and have been around for centuries. The oldest known mortgage dates back to ancient Babylon, about 4,000 years ago. Back then, the loan was not for just any old purchase; it was mainly used to buy farmland or crops.
How do mortgages work?
Firstly, to apply for a mortgage, you will need a downpayment. This downpayment is a sum of money that you pay upfront to cover the rest of the sale price and the interest on the loan.
Your lender will determine the amount you’ll need as a downpayment. However, it can change depending on things like your credit score and loan-to-value ratio (LVR).
After being approved for a mortgage, the next step is to pay it back over time. Repayments can be monthly or in a lump sum at the end of the loan, but they will be a combination of both in most cases.
After you borrow money from your lender, this money is paid out to your solicitor to cover the costs of purchasing the house.
At the same time, you will make regular repayments to your lender. These payments include the interest on the loan and a portion of what you originally borrowed.
In other words, your dream house purchase is costing you more than just the money you initially put down for the property!
Parties involved in the process:
There are mainly three parties involved in the mortgage process that you need to know when buying a house.
1. The bank or lender: This is the company that you borrow money from to pay for your house.
2. The solicitor: Your solicitor is a professional who will guide you through the legal contracts and paperwork involved in buying a property, as well as manage the exchange of money between buyer and seller. You can find out more about solicitors here.
3. The borrower: This is you or anyone else who takes out a mortgage on the property.
Difference between a Loan and Mortgage
A loan is when you borrow money from someone to finance an asset purchase, such as buying your first home or vehicle. You can either pay back the entire amount in one go after a fixed period or within a set number of months.
On the other hand, a mortgage is a type of loan that you use to pay for property such as land and houses. This type of loan is repaid over time with interest added. It must be paid back within a certain period (typically 25-30 years). This type of debt allows you to take out a larger loan than you could with other types of loans.
Five things you should know before applying for a mortgage loan
Mortgages can become complicated sometimes. So it is important to make sure you know everything about it. Here are some of the most important things to keep in mind while getting a mortgage:
1. Your credit score:
Your credit score plays a huge part in the mortgage process. Lenders will look at your score to determine how likely you are to repay a loan on time. They will also look at other credit score-related things like outstanding debts or how much money you have already borrowed.
A high credit score means lower interest rates and better lending terms. And low credit score means higher interest rates and stricter lending conditions. You might not even qualify for a loan if your credit score is too low.
2. Loan-to-value ratio (LVR):
The LVR is the amount of money you are borrowing in comparison to the value of your property. The higher this number, the less you can borrow from a lender and vice versa.
It’s best to have as low an LVR as possible when applying for a mortgage. Your LVR will be determined by things like your income, savings, credit score, and how much you can afford to pay for your house.
3. Interest rates:
Your lender can charge a different interest rate for each mortgage term. For example, your lender could offer a fixed interest rate for one year, two years, or five years.
It is worth shopping around and comparing offers from different lenders to find the best deal you can get with the least amount of risk.
4. Down payment:
Down payment is the amount of money you pay upfront when you purchase a property, usually in addition to the existing loan on the property. Lenders will calculate how much money they want for your down payment based on things like your income, savings, and credit score.
5. Loan repayment type:
There are two types of loan repayments you can make when borrowing money from a lender. They are known as interest-only and principal-and-interest.
With an interest-only repayment, you repay the interest on your home loan every month but don’t pay anything towards the actual amount that you owe. You will still have to repay the total amount of money that you borrowed.
With a principle-and-interest loan repayment, you repay both interest and part of your loan amount every month.
Advantages and disadvantages of mortgage loans
Mortgages can be a great way of financing your property purchase if you understand what you’re getting yourself into. In the following table, we’ve compared the good and bad points about mortgages:
1. Flexible loan repayment terms: You can choose the length of your mortgage term, which means you can change it if needed. So, for example, if times are tough and you need to save money on your repayments for a month or two, you can do that.
You might want to pay more than required each month to reduce the amount of interest you pay or perhaps reduce payments completely while you save.
2. Allows you to build equity: Mortgages allow you to pay off your loan over time, which means this amount will decrease. This is called building equity in your property. It will enable you to buy more expensive properties as your income increases.
3. Can protect you against rising interest rates: Fixed-term mortgages allow you to lock in an interest rate for the term of your loan. This means that if interest rates rise, this will not affect you until your fixed-term mortgage is finished.
4. Tax deductions: You can claim tax deductions on interest repayments for your home loan.
1. Interest repayments are higher than rental payments: If you’re renting your property, it’s more expensive to pay off a loan than it is to pay rental payments.
This means that if you have the option of buying a property, you should compare it to how much money you would save by staying in a rental property.
2. High risk: When borrowing money from a bank or other lender, there is always the risk that you will not be able to repay your loan. This means you could lose your property, which can also mean losing all the money you have paid towards it over time as well.
3. Property must be valued at market price: If your property’s value suddenly decreases due to an economic depression, you might not be able to sell it for as much as your outstanding loan amount.
This could mean having property worth less than what you owed and being unable to sell it or repay the difference, which is called negative equity.
Mortgages are an important way of financing property purchases. But you need to understand exactly what they are before getting one. Make sure you find the best possible deal by comparing different lenders.
Once you find the one you like, make sure to check the contract’s small print before signing on the dotted line. You can also hire a property agent if you’re not sure about what you’re doing!