What is a mortgage?

What is a mortgage?

A mortgage is a loan from a bank or a non-bank lender such as a mortgage broker. The loan is given to a person to purchase a property or a piece of land for later building. A mortgage loan gives the lender a claim on the asset (property) if the repayment requirements are unmet.

A mortgage works by the lender allowing the person to borrow money for real estate, where the borrower must repay the loan over a said period.

Deposit and Interest:

To obtain a mortgage loan, the borrower must put down a deposit on the real estate. A deposit is the payment of a small percentage of the total amount of the property that must be paid upfront to obtain the property and secure a mortgage loan. It is likely that the borrower will see a deposit of 10-20%, with 20% being far more likely in today’s environment. This means that if a property is worth $1,000,000, the borrower must down a 20% deposit, so $200,000 and you will obtain a mortgage of $800,000. You are still able to obtain a 10% deposit in a small number of cases, whether this is directed at new build homes or new build townhouses, it is still possible but have in mind that 20% is far more common.

Mortgage rates are a very common and highly talked about aspect in the financial world, a mortgage rate is basically the interest rate that is obtained for the mortgage loan. This interest rate is a percentage of the total borrowing that must be paid back to the lender on top of the payments made to reduce the loan amount. This, in turn, is how the lender makes money from giving you the loan. Now it is important to note that the lowest interest rate will be the most ideal, so it is essential for any person to do their homework and shop around to ensure that they are getting the best deal possible as a small change in interest rates on a loan like a mortgage due to it being so large in nature can make a major difference to the monthly amount being paid and a major difference to the amount at the end of the loan duration.

Bank vs Non-Bank Lenders

There are two main types of lenders when it comes to mortgage loans, firstly being the bank, which is the most common and popular option. A mortgage loan, when taken out from a bank, is said to be more secure due to it having the backing of a major commercial bank and potentially may have better interest rates. However, many people take loans from non-bank lenders such as mortgage brokers due to the fact that in some cases, they do not require as much of a rigorous background check on your finances and personal life as banks do.

Banks require a large background check on your finances which may be ongoing for several months while a person is in the application stage of the loan process but may still be undertaken regularly even when the application is approved to ensure that you remain within their standards of spending and overall financial position. Banks will likely check day-to-day spending, income changes, and will look at your finances from a critical lens to ensure that they are satisfied and confident that you will be able to pay back the loan without it being detrimental to the borrower.

Fixed vs Floating Rate:

When it comes to interest rates with mortgages there are two main types that are utilized these being both fixed and floating. A fixed interest home loan is when the interest rate for the loan is fixed at a set rate. This rate is usually fixed for a period of 6 months to a maximum of 5 years, after this period you will then have to decide whether to re-fix the interest rate for another set period or change it to a floating rate. There are many advantages to having a fixed home loan interest rate, one being that because you have a fixed interest rate this means that you will know exactly how much each repayment will be over the period. Another advantage is that you can lock in a potentially lower interest rate interest rate, which is beneficial as it can mitigate the risk of feeling the impact of a rise in interest rates as you are locked into the fixed rate. Many banks will compete with their fixed rate mortgage loans, being that they compete on the offered interest rate and the timeframe it is available for, by doing this often you can get a rate that is potentially less than the going market rate which will save you some money.

When it comes to a floating rate, this is where the interest rate is increased and decreased usually as an adjustment to the going market rate, and usually correlated to the OCR (Official Cash Rate). If a floating rate is chosen this means that your interest rate will indeed fluctuate up and down meaning that repayments will be different depending on how the interest rate has changed, and if they go up by a lot this can put stress on your finances due to the repayments being larger. These floating rates have historically been higher than the fixed interest rates seen around New Zealand. However, it is not all negatives for a floating interest rate because a floating interest rate can allow you to pay extra repayments usually with no penalty and in turn this will reduce your loan term.

Another option is to split the loan into a mix of both Fixed and Floating, this allows you to benefit from the lower rates of a fixed interest rate on a portion of the loan while also allowing you to make extra repayments on the floating portion without charge or penalty. This mix can be adjusted depending on your goals or financial capacity.

What to consider when applying for a Mortgage loan?

Spending and Credit Score:

When you approach a bank or mortgage broker, besides the forms that you must fill in the first thing they will have a look at is both your everyday spending habits and your current credit score. All lenders must protect themselves when loaning such a large o=amount of money out and one of their many checks that they will conduct on you through this investigation will be looking through all your recent bank statements to analyze your spending patterns and habits. They do this to ensure that they are safe and comfortable with the way that you spend money and that it will not cause an impact on paying back the repayments with interest on time every time.

When it comes to it the bank will also do a rigorous investigation into your credit score, this is also another form of screening to ensure they are also remaining as safe as possible with who they accept for these high dollar loans. So, if you have any bad debt or other loans such as a car loan, credits cards etc., the bank will take this into consideration and will likely create a large impact on whether they will accept you for the loan. So be cautious with your credit score and try to pay off your other loans as much as possible before applying to get the best possible chance for acceptance.

Student Loan:

There is a large misconception behind student loans and what they mean when applying for a mortgage loan. Basically, the lender does not take your mortgage loan into consideration as debt, but they do however take the yearly compulsory 12% student loan repayment directly off your total income when working out how much can be borrowed. So, if you make $100,000 per year the bank will likely only recognize your income at as estimated $88,000, which will directly impact how much you can borrow.

Details on historical mortgage rates and repayments (with graphs)