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Mortgages home loans

A mortgage is an agreement that allows a borrower to use property as collateral to secure a loan.

In most cases, the term refers to a home loan: When you borrow to buy a house, you sign an agreement saying that your lender has the right to take action if you don't make your required payments on the loan. Most importantly, the bank can take the property in foreclosure forcing you to move out so they can sell the home.

The sales proceeds will be used to pay off any debt you still owe on the property.

A Mortgage Is an Agreement:

The terms "mortgage" and "home loan" are often used interchangeably. Technically, a mortgage is the agreement that makes your home loan possible not the loan itself. For real estate transactions, agreements need to be in writing, and a mortgage is a document that (among other things) gives your lender the right to foreclose on your home.

Mortgages Make It Possible to Buy

Real estate is expensive. Most people don't have enough cash in savings to buy a home, so they make a down payment of 20 percent or so and borrow the rest. That still leaves the need for hundreds of thousands of dollars in many markets. Banks are only willing to give you that much money when they have a way to reduce their risk.

Safer for banks: Banks protect themselves by requiring you to use the property you're buying as collateral. To do so, you "pledge" the property as collateral, and that pledge is your "mortgage." In the fine print of your agreement, the bank gets permission to put a lien on your home so that they can foreclose if needed.

More Affordable Loans:

Borrowers also get some benefit out of this arrangement. By helping the lender reduce risk, the borrower pays a lower interest rate. Mortgages are often used by consumers (individuals and families), but businesses and other organizations can also purchase property with a mortgage.

Types of Mortgages

There are several different types of mortgages, and understanding the terminology can help you pick the right loan for your situation (and avoid going down the wrong path).

Again, if you want to be a stickler, we're talking about different types of loans not different types of mortgages (because the mortgage is simply the part that says they can foreclose if you stop making payments).

When that happens, your monthly payment also changes for better or worse (if interest rates go up, your payment will increase, but if rates fall, you might see lower required monthly payments).

Rates typically change after several years, and there are some limits as to how much the rate can move. These loans can be risky because you don't know what your monthly payment will be in 10 years (or if you'll be able to afford it).

Second mortgages, also known as home equity loans, aren't for buying a house they're for borrowing against a property you already own. To do so, you'll add another mortgage (if your home is paid off, you're putting a new, first, mortgage on the home). Your second mortgage lender is typically "in second position," meaning they only get paid if there's money left over after the first mortgage holder gets paid. Second mortgages are sometimes used to pay for home improvements and higher education. In the financial crisis, these loans were notoriously used to "cash out" your home equity.

Reverse mortgages provide income to homeowners (generally over the age of 62) who have significant equity in their homes. Retirees sometimes use a reverse mortgage to supplement income or to get lump sums of cash out of homes that they paid off long ago. With a reverse mortgage, you don't pay the lender the lender pays you but these loans are not always as good as they sound.

Interest only loans allow you to pay only the interest costs on your loan each month. As a result, you'll have a smaller monthly payment (because you're not repaying any of your loan balance). The drawback is that you're not paying down debt and building equity in your home, and you'll have to repay that debt someday. These loans can make sense in certain short-term situations, but they're not the best option for most homeowners hoping to build wealth.

Balloon loans require that you pay off the loan entirely with a large "balloon" payment. Instead of making the same payment over 15 or 30 years, you'll have to make a large payment to eliminate the debt (after five to seven years, for example).

These loans work for temporary financing, but it's risky to assume that you'll have access to the funds you need when the balloon payment is due.

Refinance loans allow you to swap out one mortgage for another if you find a better deal. When you refinance a mortgage, you get a new mortgage that pays off the old loan. This process can be expensive because of closing costs, but it can pay off over the long term if you get the numbers to line up correctly. The loans don't need to be the same type. For example, you can get a fixed-rate loan to pay off an adjustable rate mortgage.

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