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Dissecting a mortgage

Most people understand the basic gist of what a mortgage is. It is something that allows you to borrow a large sum of money to buy a home. If you are going to pay so much for this thing, this mortgage, you may want to have a better understanding of what it actually is.

“The Anatomy of a Mortgage” is an article posted on loansrc.com, which explains the components and intricacies of a mortgage.

“What exactly is a mortgage? Simply put, it's a loan from a financial institution to you. In return, you pay interest on the amount loaned. The lender also has first dibs on your house in case you neglect to pay back the loan.”

There are three main components of a mortgage; size (how much you need to borrow), interest (the percentage rate you pay on the loan) and term (the amount of time it will take to pay off the loan).

The size of the loan is pretty much self explanatory. You may not want to take out as much as you qualify for, to save your premium from being too high.

The interest rate is usually discussed in terms of APR, or the annual percentage rate.

“The annual percentage rate is a method developed under federal law to disclose to loan applicants the actual amount of interest that will be paid on a given loan, over the life of that loan. It makes it easy to compare one mortgage to another by making it an apples-to-apples comparison.”

An important thing to know is that APRs use points. A point is equivalent to one percent of the loan amount. So, if a loan is $100,000, one point equals $1,000.

“There are two types of points: origination and discount. Origination points are the fees normally charged by a lender, for originating, or starting up, your loan. Discount points are charged to lower your interest rate, and this lowers your payments. In other words, if you pay some more money up front, the bank will let you pay less over time.”

Both types of points should be considered interest that you pay upfront. Don’t forget to calculate points into your loan repayment.

So, if you take out a loan for $120,000 at nine percent interest for 30 years, and you pay one origination and one discount point, you’re paying a total of two points which equals $2,400. Thus your monthly payment will be $965.55 per month.

“To get the proper APR on your loan, then, you have to add that $2,400 to your starting balance. This makes your total loan $122,400. Figure the new payment on that balance, which works out to $984.00. Now return to the original loan amount and (ready, mathematicians?) compute the polynomial backwards to reach the interest rate it would take to equal the payment on the total loan. It works out to roughly 9.23%.

Maybe it is not the easiest thing to compute, but you can work the formula.

Finally, you should understand terms. The most common terms are 15-year and 30-year terms.

A 15-year term will have a higher monthly payment, but you will pay the loan off in half the time.

Conversely, a 30-year term will have lower monthly payments but higher interest rates. This means that not only will you be taking twice as long to pay the loan; you will also end up paying much more for it.

Now you really know the basics. Still, whenever you apply for a mortgage loan, take your time and read all the term carefully.
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