One of the central roles of a real estate agent is to teach clients about the process of buying and selling a home. Some of your clients will have been through the steps before – perhaps multiple times. However, some clients will be new and require much more hand-holding and encouragement. Some may not even have a basic understanding of what it takes to buy a home and may ask, “What does ‘mortgage’ mean in real estate?”
Here’s some guidance on how to answer that question. We’ll also help you explain the different types of mortgages and how they work.
While you may be surprised by how little your client knows, don’t judge them for asking. Develop a reputation for being patient and supportive during the process, and your clients are more likely to recommend you to their friends.
What Is a Mortgage?
A mortgage is a type of loan specifically used to purchase real estate, such as a house or land. It is a secured loan, meaning the property being purchased serves as collateral for the loan. This means if the borrower (homebuyer) fails to repay the loan according to the agreed terms, the lender has the right to take possession of the property through a legal process known as foreclosure.
Mortgages allow people to buy homes without paying the total purchase price upfront. A mortgage makes homeownership more accessible.
How Mortgages Work
Here are the key components of a mortgage. Your client needs to understand how all these factors determine how much they will pay for their home.
1. Down payment
The borrower typically makes an initial payment, called a down payment, which is usually 20% of the property’s purchase price. Although there may be ways to get a mortgage with less than a 20% down payment, the borrower may need private mortgage insurance (PMI).
2. Loan amount
The lender provides the remaining amount needed to purchase the property, which is called the loan’s “principal.” The lender will assess the property’s value and won’t allow the buyer to borrow more money than the property is worth.
3. Interest rate
The borrower agrees to pay back the loan with interest, which is the cost of borrowing the money. It’s crucial that the buyer understands the actual amount they will have to pay for their home, as this includes both principal and interest. Consider the following scenario:
For a $250,000 home with a 30-year mortgage at a 6% fixed interest rate:
- Monthly Payment: $1,498.88
- Total Interest Paid: $289,595.47
- Total Cost Over 30 Years: $539,595.47
This means that over the course of the loan, the buyer will pay an additional $289,595.47 in interest, making the total cost of the home $539,595.47.
4. Term of the loan
The borrower repays the loan over a set period, usually 15 to 30 years, through regular monthly payments. These payments typically cover both the principal and the interest.
Over time, the proportion of the payment that goes towards the principal increases while the interest portion decreases. This is called amortization.
3 Critical Aspects of Mortgages Your Buyer Must Understand
Your buyer must understand that purchasing a property is a significant financial decision.
- The borrower holds the title to the property and is considered the owner, but the lender has a lien on the property until the mortgage is fully paid.
- If the borrower fails to make the required payments, the lender can initiate foreclosure to recover the outstanding loan amount by selling the property.
- In addition to the monthly payment that goes toward the principal and interest of the loan, the buyer is also responsible for paying property taxes and homeowner’s insurance. These taxes and insurance premiums are often added to the homeowner’s monthly mortgage payment.
This information will be discussed at the buyer’s closing appointment, but it’s critical that they understand it before entering the final part of the process.
Types of Mortgages
There are many different types of mortgages. Here’s a summary of the most common types of mortgages. As an added resource, share Homebuyer’s Home Guide: 7 Types of Mortgage Home Loans with your clients, which also offers the pros and cons of each type.
1. Fixed-rate mortgage
A fixed-rate mortgage is a home loan where the interest rate stays constant for the entire repayment period. This ensures that the borrower’s monthly mortgage payments remain consistent throughout the life of the loan unless there are changes in homeowners insurance premiums or property tax rates. This type of loan offers predictability and stability.
2. Adjustable-rate mortgage (ARM)
An adjustable-rate mortgage (often called an ARM) is a type of home loan in which the interest rate is variable and can change based on market conditions. Unlike a fixed-rate mortgage, the interest rate on an ARM can increase or decrease during the repayment term.
ARMs usually start with an initial fixed-rate period, during which the interest rate remains stable for a set time, typically between 3 and 10 years. This initial period’s interest rate is generally lower than that of fixed-rate mortgages. Once this period ends, the rate on an ARM adjusts annually.
Related article: What Is an Adjustable-Rate Mortgage in Real Estate?
3. Interest-only mortgage
An interest-only mortgage is a type of home loan in which the borrower pays only the interest for a specified period, usually 5 to 10 years. During this initial period, the monthly payments are lower because they don’t include any repayment of the loan principal. After the interest-only period ends, the borrower must begin paying both principal and interest, often resulting in significantly higher monthly payments.
4. Reverse mortgage
Even though the word “mortgage” is in the title, a reverse mortgage is not an option for someone buying a property. Instead, a reverse mortgage is a financial product designed for homeowners aged 62 and older, allowing them to convert part of their home equity into cash without selling their home. Unlike a traditional mortgage, where the borrower makes monthly payments to the lender, a reverse mortgage pays the homeowner. The loan is repaid when the homeowner sells the house, moves out, or passes away.
5. Jumbo mortgage
A jumbo mortgage loan is typically used for high-value properties. They require larger down payments and higher credit scores. Due to their higher risk, jumbo loans often have elevated interest rates.
6. FHA mortgage
FHA loans are insured by the Federal Housing Administration, which operates under the Department of Housing and Urban Development (HUD). Overall, FHA loans are an option for those who may not meet conventional loan requirements or have limited funds for a down payment.
Related Article: What Is an FHA Loan in Real Estate?
Encourage your buyer client to talk with a mortgage provider, who will help them find the best home loan product based on their credit history and current financial situation.
Advantages & Disadvantages of Having a Mortgage
While you can teach your clients about mortgages, including how they work and the different types, they must decide on their own if they are ready to borrow money to buy property. Here are the advantages and disadvantages of having a mortgage.
Advantages of having a mortgage
Here are some advantages of getting a mortgage to buy a home.
- Homeownership: A mortgage allows buyers to purchase a home without paying the entire price upfront. Mortgages make homeownership accessible to more people.
- Builds equity: As a buyer pays off their mortgage, they build equity in the home, which can increase their net worth.
- Tax benefits: Mortgage interest payments are often tax-deductible, reducing the taxpayer’s taxable income and potentially saving them money.
- Potential for appreciation: Real estate often appreciates or grows in value over time, so owning a home with a mortgage can increase a person’s wealth as property values rise.
- Forced savings: Regular mortgage payments can serve as a form of forced savings, helping homeowners accumulate wealth over time.
- Stability: Owning a home can provide stability, allowing a buyer to settle in a community, personalize their living space, and avoid the uncertainties of renting.
Overall, a mortgage can be a powerful financial tool offering immediate and long-term benefits.
Disadvantages of having a mortgage
The most obvious disadvantage of having a mortgage is that it is a long-term debt. Here are the disadvantages of borrowing money for a home.
- Long-term debt: A mortgage is a long-term commitment, often lasting 15 to 30 years, which means carrying significant debt for a large portion of one’s life.
- Interest costs: Over the life of the loan, the interest paid can significantly increase the home’s total cost, sometimes doubling the amount the homeowner initially borrowed.
- Risk of foreclosure: Buyers risk losing their homes through foreclosure if they fall behind on their payments.
- Upfront costs: Obtaining a mortgage involves various upfront costs, including down payments, closing costs, and fees, which can be substantial.
- Property value fluctuations: Real estate markets can be unpredictable, and if property values decrease, a property owner could end up owing more on their mortgage than the home is worth (known as being “underwater”).
- Financial pressure: The obligation to make regular mortgage payments can add financial pressure, especially during times of economic hardship, such as job loss or medical emergencies.
- Insurance and taxes: In addition to the mortgage payment, homeowners are responsible for property taxes and homeowner’s insurance, which can increase the overall cost of homeownership.
While a mortgage can make homeownership achievable, it also comes with financial risks and responsibilities that require careful consideration and planning.
What Are the Key Features for Comparing Different Mortgages?
When choosing a mortgage, your client should consider several key features. Encourage your clients to shop around for the best deals.
Loan term
The length of time a buyer has to repay a mortgage typically ranges from 15 to 30 years. Shorter terms generally come with higher monthly payments but lower overall interest costs.
Interest rate
A loan’s interest rate is a crucial variable. Mortgage interest rates are determined by a combination of factors, including the borrower’s credit score, loan amount, and down payment, as well as broader economic conditions such as inflation, the Federal Reserve’s policy, and the bond market. Sometimes, a borrower can purchase “points,” or optional fees paid at closing to lower the interest rate.
Closing costs
There are additional fees and expenses associated with finalizing a mortgage, including appraisal fees, title insurance, and origination fees. These costs are typically paid at the time of closing.
Understanding these features can help borrowers choose the right mortgage for their financial situation and long-term goals.
Turn to Colibri Real Estate School for more helpful articles about buying and selling real estate – and the real estate licensing process. We also offer continuing education courses and broker licensing courses.
Key Takeaways
- A mortgage is a secured loan used to purchase real estate, with the property serving as collateral. It allows buyers to acquire a home without paying the total purchase price upfront, making homeownership more accessible.
- There are various types of mortgages, including fixed-rate, adjustable-rate, interest-only, reverse, jumbo, and FHA loans, each catering to different financial situations and borrower needs.
- Key components of a mortgage include the down payment, loan amount, interest rate, and loan term. Borrowers need to understand how these factors affect the home’s total cost and monthly payments.
- While mortgages offer benefits such as homeownership, equity building, and potential tax savings, they also come with risks like long-term debt, interest costs, and the possibility of foreclosure, requiring careful consideration before committing.
