Define Mortgage Financing

Choosing the right mortgage can be the difference between a comfortable living arrangement and a nightmare scenario where you are evicted and out on the street. Mortgage debt contracts vary according to duration and structure. For consumers, the extensive selections of complex mortgage products may appear to be overwhelming. In preparation, you should become familiar with basic home loan terminology, while also anticipating lender expectations for these mortgage contracts.

Define Mortgage Principal

Mortgage debt is used to buy real estate. The real estate secures, or backs, the mortgage loan as collateral. During the mortgage application process, the bank hires an appraiser to estimate the value of your future home. From there, the bank can ensure that your bid lines up with economic reality. The bank will approve a mortgage principal that may be added to your down payment to equal the home's initial value. Mortgage principal refers to the loan balance that is to be paid off.

The Mortgage Payment

A full mortgage bill is divided into principal and interest payments alongside escrow account deposits. The mortgage company manages an escrow account on your behalf to meet property tax and private mortgage insurance (PMI) obligations. Municipal officials spend property tax revenue to provide local services, such as city police staffing and street maintenance. PMI lowers risks for banks, which translates into lower mortgage rates. The PMI coverage pays a settlement to the lender, if you were to miss mortgage payments and default on the loan.

Home Equity

Mortgage principal payments reduce your outstanding debt balance. When property values are stable, these payments will establish home equity. Home equity describes financial ownership and is the difference between a property's value and its mortgage principal. Mortgage payments therefore increase equity, by lowering your principal balance.

Types of Mortgages

Home loans are categorized as either fixed-rate or adjustable-rate mortgages (ARMs). Fixed-rate mortgages post level interest rates, which may extend for 15 or 30 years until loan maturity. 30-year fixed mortgages generally charge higher rates compared to 15-year fixed mortgages. The higher rates compensate the bank for increased financial risks that come with time. For example, the higher interest rates must account for inflation that effectively devalues the purchasing power of your future payments.

ARMs, however, feature interest rates that shift alongside a particular index. Investopedia says that ARM rates and payments are usually recalculated every month. For example, your ARM may determine its monthly interest rate by adding a five percent premium to the 12-month London Interbank Offered Rate. Some ARMs feature low fixed rates for an introductory period of between 12 and 36 months, before interest payments move significantly higher.

Mortgage Foreclosures

Mortgage foreclosure risks increase amid recession. In recession, people suffer from job layoffs and investment losses. Further, property value declines could result in negative equity situations, where home loan balances exceed real estate prices. At that point, the home cannot be sold for enough cash to make good on the loan. You should build a cash cushion worth six months of mortgage payments to alleviate these risks.

Define Mortgage Financing, Sources:

Investopedia: Adjustable-Rate Mortgage (ARM)

Investopedia: Mortgage

CNN Money: The 3 Stages of Foreclosures