Home ownership has been recognized as an American value from the country’s earliest days and it continues to exercise a strong pull. There is a natural desire for the sense of security owning a house provides, and once you have found a neighborhood that meets your needs, it makes sense to buy a home and settle down.
While very wealthy people do not need to borrow money to buy a house, the fact that houses cost many times more than average yearly salaries mean that most of us do need to borrow to buy a house and hence, the market for mortgages. Although many mortgage payers might view their payments with the same degree of annoyance they feel towards paying taxes, they cannot fail to recognize that for most people the mortgage is the passport to home ownership.
A strong mortgage market
While other markets decline, the US mortgage market is giving the opposite indications. Despite record unemployment rates and the most dramatic downfall in housing values since the Great Depression, the Mortgage Bankers Association has recorded a significant increase in mortgage applications in the first week of September.
Advantages of a mortgage
While the principal benefit of the mortgage for the borrower is bridging the gap between their own funds and the cost of the house they want to purchase, there are a number of other significant advantages:
- It is preferable to pay the mortgage payments to the bank with the knowledge that this money is going towards buying your own home, rather than renting and effectively helping another person pay for their home. It is also common for the cost of paying a mortgage to be less than the costs of renting a house when calculated over a long period.
- Home ownership also has tax benefits. Mortgage interest on a first home is deductible and the interest on a second home is also often tax deductible. Furthermore, mortgage insurance premiums are tax deductible in certain cases.
- Over the long term the house can be expected to appreciate in value considerably more than the original purchase price and so the mortgage can be seen as financing a sound investment in real estate. Unlike renting, buying a house gives you a saleable asset at the end of the day.
How Mortgages Work
Mortgage payments include a sum to cover both the principal (the sum borrowed) and the interest. Normally the house buyer pays a certain percentage of the purchase price from their own funds and they obtain the remainder from a bank or other mortgage lender. Usually the buyer pays between 10% to 20% of the house price up front from their own funds, and borrows the rest in the form of a mortgage; although there are cases where the upfront payment may be as low as 3% this is going to make the mortgage that much more expensive.
The period of the mortgage can vary with ten, fifteen, twenty and thirty year mortgages being the most widespread. The shorter the period of the mortgage, the higher the monthly payments are going to be.
Mortgages can be a fixed rate or have a variable interest rate. In the latter case, the interest rate is normally based on an index; for example, the US Treasury one year index, plus an additional margin. There are also combination fixed and variable rate mortgages where the fixed rate applies for a set number of years and afterwards a variable rate applies.
Similar to other loan types, the bank profits from the interest payments charged on the money borrowed and administrative fees associated with the mortgage application. A critical difference from many other loan types is the fact that the house provides security for the mortgage with the title of the property remaining in the bank’s hands until the mortgage is paid or alternatively, the borrower gets the title while the bank acquires a lien on the property that allows them to sell it if the borrower ceases to honor their obligations.
While the term “mortgage” on its own is invariably used to describe a loan taken out to buy a first home, there is also a thriving market in second mortgages for financing the purchase of additional properties, refinancing an existing mortgage and home improvements as well as a number of other purposes. Second mortgages come in various forms, with HELOCs and home equity loans as the best-known options. Second mortgages and the differences between them and primary mortgages is a subject in its own right.