What is a Mortgage?
A mortgage is a loan secured against a property. Mortgages are typically used for the procurement of an individual's home though they can also be used for purchasing business properties of a house which is then let out as an investment. This article and mortgage calculator looks at a mortagage which uses a compound interest calculation with regularly monthly repayments (the majority of mortgage products use this approach now), you may also want to review our Balloon Mortgage Calculator.
How Do mortgages work?
Mortgages are a fairly straight forward loan with interest added to the amount owed (the principal) at specific periods, normally monthly. Interest is normally based on an annual percentage rate (APR). When interest is calculated monthly, the APR is divided by 12 are applied at each periodic point. This type of interest calculation is called compound interest. The amount of interest you pay on a compound interest mortgage depends on the frequency of payments, the term of the mortgage (how long it takes you to the repay the mortgage in full) and the APR. Compound interest is also used to calculate saving investments and other types of loans including credit cards, personal loans and car loans.
What should I look for when searching for a mortgage.
If you are new to mortgages, it may seem like a world full of jargon and hidden or unclear financial costs and commitments. The good news is that this article will help you understand the key elements of a mortgage and what to look for when searching for a mortgage for your first home.
If you already have a mortgage and are looking to remortgage your property of perhaps take a new mortgage for a second home, this article will help refresh your memory on the key factors when finding the best mortgage deal.
So, what makes a good mortgage deal? I all comes down to the key elements of the mortgage finance. Your goal should be to get the best mortgage deal for you, this is always a personal decision based on your personal finances. The key elements to securing the perfect mortgage deal are the deposit, annual income, monthly budget. The larger those three mortgage elements, the more likely you are to be able to access a great mortgage deal. Let's look at each of the factors that you should look for when reviewing a mortgage.
- APR: In simple terms, the lower the APR, the less you will pay. The key thing to remember when looking at APR is that low APR is good for borrowing, high APR is good for investing. If you are looking for your first mortgage, it is likely that you will find two or more mortgage offers with the same APR, that makes them the same right? Wrong, whilst the offers may appear to be the same (and may well be), they may offer different interest calculations.
- Interest Calculation: Earlier in this mortgage article we mentioned compound interest. Compound interest is the financial practice of calculating interest on the principal owed. Every time interest is calculated, it is added to the principal. The next time that the interest is calculated, the calculation is based on the amount including previous interest added to the principal. So, in simple terms, the more frequently you pay interest, the more interest you will pay (that is unless you are making payments faster than the interest payments). This may seem a little scary but mortgages are carefully monitored, this is purely to allow you to understand the difference in calculations. So, let’s consider this in real terms. Say you find two mortgage deals, both at at 5% APR. Mortgage one calculate the APR monthly, mortgage 2 calculates the APR annually. In this example, you would be better off. Taking the second mortgage. This is a very generic statement and meant as a guide only. In reality you should contact both mortgage lenders and ask them to provide you a mortgage repayment schedule, then you can compare both mortgages in detail and decide which mortgage is best for you. You can of course use this mortgage calculator and review the mortgage schedule here but, the mortgage lender may apply the interest slightly differently (unusual, but still a possibility). Always ask the mortgage lender for an illustration, after all it's free and you are better off having the full detail in writing.
- Repayment period: Nearly all mortgages now work on a on monthly repayment schedule. When reviewing repayment periods, check to see if you can also make additional repayments. Believe it or not, some mortgage lenders prevent you doing this. This may seem irrelevant now but, if your financial circumstances allow, it is in your best interests to pay extra money into your mortgage if / whenever you can. Paying above the regular monthly mortgage repayments will mean you pay less interest and repay your mortgage ahead of plan. Something as simple as an extra $10.00 a month can save you thousands of Dollars in the long term. An extra $10 dollars may seem impossible now, but may be a lot easier in the future.
- Mortgage Term: The mortgage term is the duration of the mortgage, normally in years. Mortgage terms vary in length. What you need to remember, The longer the mortgage term is, the less you will pay each month but the more you will pay in interest for that privilege. Shorter term mortgage mean you pay more per month but you will pay far less interest and own your home sooner.
- Introductory APR: A lot of mortgage providers now provide an introductory rate mortgage deal. This typically include a lower, fixed amount APR for the first few years. This can be perfect if you need a lower monthly payment but make sure you read the deal. Some mortgage providers will provide the lower fixed APR but stipulate that you then pay a higher than average APR at the end of the term. They may also stipulate that you retain your mortgage with them for a specific period or pay an exit fee. So, this can result in you paying more interest overall. A with all mortgage deals, consider the true financial costs.
- Mortgage Deposit: Mortgages normally require you to put a deposit down that equates to a minimum percentage of the property purchase value, say 5%. You will typically be able to access better mortgage deals if you have a larger mortgage deposit. Some mortgages don’t require a deposit, this is a 100% mortgage. 100% mortgages are very difficult to obtain since the banking crisis and property crash of the early 21st century. 100% mortgages become viable when mortgage lenders believe that the property value will increase in value at a quicker rate than interest is generated (so, the lender effectively gambles on there being enough equity to keep their investment safe), thereby ensuring that they can recoup their money if you default on the mortgage. If the property value decreases below the value of the outstanding mortgae, the property is considered to be in negative equity, meaning the full mortgage loan cannot be recouped from sale of the property. This can result in people owing large sums with no home or becoming bankrupt if they become unable to make the monthly mortgage repayments. This Situation only occurs if you cannot meet the monthly repayment. It is not unusual for property prices to fluctuate but, over time, most do increase in value due to the ever increasing demand caused by population growth. Negative equity is only a bad thing if you need to sell. Remember a house should be a home, not an asset, it is a sad thing that this seems to have been forgotten in the past 50 years or so.
- Annual Earnings: The amount you earn directly affects the amount you can borrow. The more you earn, the larger mortgage you will be able to afford.
Saving for a mortgage deposit
Saving the money for a mortgage deposit is probably the hardest part of obtaining a mortgage. The trick to savings mortgage deposit quickly is to look at your daily finances and see if there are any little changes you can make to your daily spending habits to boost that mortgage deposit pot. We have a Daily Expense Savings Calculator which provides tips to help you do just that.
We hope this basic introduction to mortgages helps you with your search for the best mortgage deal for you. If you would like us to add additional information to this mortgage article or have any comments, please post a message below.