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What is a Mortgage Loan? A Brief Overview

Updated: June 13, 2022
What is a Mortgage Loan? A Brief Overview

A mortgage loan from a financial institution or a mortgage lender is one that allows you to buy a fixed asset such as a house, or get a large amount of money by placing a fixed asset you already own as collateral. Usually, lenders provide upto 90% of the value of the property in the case of a loan for purchasing a fixed asset, and upto 70% in case of borrowing against a pre-owned fixed asset. The loan must be repaid over a period of time. In the case of loans availed to purchase new property, the new property that is acquired serves as collateral for the loan.

Types of Mortgages

Fixed rate and adjustable rate (known as variable rate) mortgages are the two most known forms of mortgages.

Fixed Rate Mortgages

Borrowers with fixed-rate mortgages have a fixed interest rate for a specified period of time, usually 15, 20, or 30 years. The fixed rate is determined and agreed upon between the lender and borrower at the time of loan sanction, and does not change with any change in the market over the entire loan tenure.

The most significant benefit of a fixed-rate mortgage is that the borrower can rely on the same monthly mortgage payment every month for the duration of the loan, even if the market rates increase in future, thereby making it easier to plan household finances and avoid any unexpected additional charges from month to month. On the minus side, such loans taken for business purposes may attract charges if the borrower chooses to make part payments or foreclose.

Adjustable Rate Mortgages

Interest rates on Adjustable Rate mortgages (ARMs) can – and usually vary over the life of the loan. Interest rates fluctuate as market rates and other factors change, affecting the amount of interest the borrower should pay and, as a result, the total monthly payment due. The interest rate on adjustable rate mortgages is set to be reviewed and modified at defined intervals. The rate may be modified once a year or every six months.

The 5/1 ARM is one of the most prominent adjustable-rate mortgages, with a fixed rate for the first 5 years of the loan term and an annual interest rate adjustment for the balance of the loan's tenure.

While adjustable-rate mortgages make it more difficult for borrowers to benefit from any changes in the market rates, they are popular because they often have smaller initial interest rates than fixed-rate mortgages. Borrowers who believe their income will increase over time may opt for an ARM to take the advantage of zero charges if they choose to make part-payments or foreclose the loan. This is mostly applicable for loans taken for non-business purposes.

Mortgages are significant financial obligations that bind borrowers to years of repayments which must be repaid on time. Most people, on the other hand, believe that the long-term advantages justify taking out a mortgage.

Advantages of a mortgage:

  • Makes it possible to own a home: For many people, having taken out a mortgage loan enables owning a home possible because saving money would take too long. You can spread the cost of a mortgage across several years using a mortgage.
  • Higher Loan Amounts: Mortgage loans allow individuals to borrow higher amounts as compared to unsecured loans.
  • Many types of Mortgages available in the market: There are many various types of mortgages offered, so you should be able to choose one that fits your needs and interests. These include fixed interest rate or variable rate mortgages, as well as the option of extending the mortgage term to reduce repayments.
  • Government introduced mortgage schemes: Under the Help to Buy name, the government has implemented a series of initiatives in recent years to assist first-time homebuyers in particular get on the property ladder. It means that purchasers can use shared ownership and equity loans, for instance, to purchase homes with a lower down payment.
  • Lower Interest Rates: Mortgage loans have lower interest rates when compared to unsecured loans.

Disadvantages of a mortgage:

  • Due to the longer tenure, the overall interest outgo is much higher.
  • There may be other applicable fees like agreement fees, mortgaging fees, valuation fees.
  • If you can't keep up with your payments, and default, the pledged property could be repossessed by the lender, causing you to lose a valuable asset.
  • Mortgage loans have longer tenures, and thus, one could be in debt for a long time. This may reduce one’s eligibility for other forms of credit such as personal loans. Thus, it is strongly advised to speak to one’s lender and understand the policy of part payments / increasing EMIs so that one can repay their mortgage loans as quickly as possible.

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