What is a Mortgage?

Category ยท First-Time Home Buyers

Published on August 1, 2017

For a first-time home buyer interested in building wealth, the rent versus buy decision is often confusing. Studies one month indicate people come out ahead by owning a home, while other times it sounds better to remain a renter. When a first-time home buyer asks, "What is a mortgage?" the answers include differences between fixed-rate, adjustable rate mortgages as well tax deductions. For most Americans, a mortgage isn't just a way to own a home. It's also a forced savings account. Every time you make a mortgage payment, you create wealth in the form of home equity. As your home value goes up, you gain even more equity in your home. According to an article by houstonchronicle.com, buying a home is a steady and slow way to build wealth. The 2014 Survey of Consumer Finances showed a median net worth of almost $200,000 for home owners compared to the $5,000 renter's net worth. In other words, home owners have 40 times the net worth. To determine your net worth, simply add up all of your assets, cash and home equity. Then subtract all debts or money owed. The article calls home ownership a "wealth-building cocktail" that includes tax advantage, leverage and automated investing.

Understanding the basics

Some first-time home buyers wonder about the mortgage payment. Typically, a mortgage payment includes the principle on the mortgage loan, the interest, property taxes and insurance. Some home owners have Home Owner Association fees, which they pay as a separate bill. Lenders combine the property tax and insurance as an "escrow" amount. The escrow is money put aside to cover fluctuating property tax and insurance costs. Most home owners get a small bill or a small refund based on the escrow savings each year. Understanding the mortgage payment breakdown is often confusing for first-time home buyers.

Picking the best terms

As a potential home buyer, a mortgage lender goes over various mortgage programs. Some home owners opt for a 15-year mortgage, but most choose a 30-year fixed rate plan. With a 15 year term, a home owner typically pays a higher monthly payment but receives a lower interest rate. An adjustable rate mortgage is one that includes a fixed rate term combined with a flexible rate tied to the government's prime rate. If you want to more reliable budget, opt for a fixed rate mortgage. Most home owners avoid an interest-only mortgage unless they plan to flip a home or buy and sell it for a profit in less than one year. In a rapidly appreciating home market, an interest-only mortgage is a non-traditional option for more aggressive borrowers able to handle risk.

Making your savings automatic

The reason many financial gurus love home ownership as a vehicle to build wealth is because it's a form of automated investing. Every month, you make your mortgage payment. When you hand a rent check over the landlord, you never see the money again. When you pay the mortgage, you get closer to owning the home outright. Even if you owe $100,000 on a home worth $250,000, you have $150,000 in equity. After paying off a mortgage, you clear the debt, owing only your annual property taxes. Years ago, people had "mortgage-burning" parties to celebrate having paid off their mortgages. Today, most new home owners rather celebrate the fact that they found a great home they could afford. Other advantages of owning a home include a tax deduction if you itemize taxes as well as capital gains exclusion if you make a profit when you sell.

At First Savings Mortgage, we help new home buyers figure out what a mortgage means for their financial future. For more information about mortgage programs, please contact us.