Most people find it difficult to invest in Real Estate without getting a mortgage. So what is a mortgage?
A mortgage is essentially a legal agreement between two parties where one party has money, the lender, and another party wants to buy property, the borrower. The agreement is that in exchange for the lender paying for the property the borrower wants to buy, the borrower will make payments to the lender for an agreed upon period of time until full payment has been made. Upon full payment, the mortgage becomes satisfied and the lender goes away with the borrower turning into an owner, owning the property outright.
The incentive for a lender to provide a mortgage for the borrower is interest. Interest is a percentage of the loan that the borrower pays the lender for the convenience of having the loan. For instance, if I wanted to buy a house for $100,000, but I did not have the money to buy it outright, I would borrow from a lender. The lender would pay the seller of the property $100,000 on my behalf. In return for their generosity, I, the borrower, would pay the lender not only the $100,000 they paid on my behalf, but I would also pay an interest rate, or percentage of the loan’s balance (the amount I have left to pay). If the interest rate were 10%, I would pay $10,000 to the lender for the convenience of having a loan I can pay off over time, as well as the $100,000, the original loan.
Nearly all real estate lenders provide a mortgage that has interest, which is compounded daily. This means that if the borrower’s loan is 6% interest per year, they will charge 6% divided by 360 days, then multiply that number times the current balance. They do this math every day, adding up the interest and sending a bill for the interest amount along with a proportionate amount of principal to be paid down over the life of the loan. Most loans are for 30 years; however, there are many that are 1, 2, 5, 10, and 15 year loans available, too. Here’s how the math would work to determine the daily interest. If I owe $100,000 and my interest rate is 6%, my lender would charge me 6% divided by 360 (banks use a 360 day year for accounting), or 0.000166 per day. This means that until the borrower makes a payment toward the principal, the borrower would have to pay $100,000 x 0.000166 per day, or $16.67 per day just for the benefit of having the mortgage in the first place. The percentage paid over the whole year is the Annual Percentage Rate, or APR. The lower the APR, the cheaper it is to borrow and the lower the payment. For instance, a 3% interest rate on a $100,000 loan would be $3,000 per year; whereas, a 10% loan would be $10,000 per year.
The mortgage not only defines what the principal and interest payments will be, it also defines the relationship between the borrower and lender and what the consequences are if the borrower fails to live up to their responsibilities of making the agreed payments. In most cases, if the borrower fails to make payments within the agreed upon timeline, the lender will foreclose, taking ownership of the underlying asset-the house.
Now that you know what a mortgage is, make sure you read my next lesson and follow me on http://www.steemit.com/@bobthebuilder
