Before taking out a loan, it’s important to learn how they work and how you can borrow smartly, safely and at the lowest possible cost. There are a few key things to understand, and the more you know, the more prepared you’ll be. Here are the mortgage loan basics.
What is a Mortgage Loan?
A mortgage is a loan from a bank or a financial institution that helps the borrower purchase a house. It’s an informal agreement, involving two parties: the borrower and the lender.
Over many years, the borrower repays the loan, plus interest, until he or she owns the property. But, if the borrower stops paying the mortgage, the lender can foreclose.
These are the essentials on how loans work:
- You take out a loan when you borrow money from a lender.
- The amount you borrow is paid back over time, plus interest and other fees.
- Lenders will require an application and consider your credit rating, income and other factors when determining loan approval.
- Interest rates are determined by your credit rating and other qualifying factors.
- Your loan’s term is the amount of time you take to pay back the amount borrowed.
Types of Loans
There are two basic types of loans: secured and unsecured.
Secured loans are ones that are protected by an asset. Whatever is being purchased with the lended money can be used as collateral by the lender. If you don’t repay as agreed, the lender can claim the collateral to pay off the debt. Because of this guarantee, the lender’s level of risk is low.
Unsecured loans do not require collateral, so they are more risky for the lender because there is no collateral to recover in case of failure to repay the loan. This is why the interest rates tend to be higher.
Common loan types include:
- Personal loans can be used to pay for nearly any use, though some lenders have restrictions. They are often used to consolidate existing debt or finance an upcoming expense.
- Business loans are for launching or operating a business. They may be secured or unsecured.
- Student loans are for higher education costs. Federal student loans are offered through the U.S. Department of Education, including undergraduate, graduate and parent loans.
- Car loans are used to buy a vehicle such as a car or truck and are typically secured by the vehicle.
- Mortgages help people buy real estate. As with car loans, the property you purchase usually acts as security for the loan.
The Loan Process
- Mortgage Pre-approval
The lender reviews your financial situation to determine how much they are willing to lend.
- House Hunting
The home buyer locates a home, negotiates the price, and signs a purchase agreement.
- Loan Application
The borrower completes a loan application with information about the home being purchased.
- Mortgage Processing
The loan processor gathers all of the information needed for the loan and creates a file.
- Mortgage Underwriting
The underwriter analyzes the loan file to determine if it should be approved or denied.
- Approval and Closing
The underwriter issues a final approval, and the home buyer attends closing to finalize the deal.