Buying a home is the embodiment of the American dream. However, that wasn’t always the case: In fact, before the 1930s, only four in 10 American families owned their own home. That’s because very few people had enough cash to buy a home in one lump sum. And until the 1930s, there was no such thing as a bank loan specifically designed to purchase a home, something we now know as a mortgage.
In simple terms, a mortgage is a loan in which your house functions as the collateral. The bank or mortgage lender loans you a large chunk of money (typically 80 percent of the price of the home), which you must pay back — with interest — over a set period of time. If you fail to pay back the loan, the lender can take your home through a legal process known as foreclosure.
In legal terms, a mortgage is “the pledging of property to a creditor as security for the payment of a debt” [source: YourDictionary.com]. In plain English, a mortgage is a loan. For many people, it’s the biggest loan they will ever borrow. With a regular loan, there’s no explicit collateral. The lender looks at your credit history, your income and your savings, and determines if you’re a good risk. With a mortgage, the collateral for the loan is the house itself. If you don’t pay back the loan (along with all of the fees and interest that are included with it), then the lender can take your house.
What Are Mortgages?
Banks are the traditional mortgage lender. You can either apply for a mortgage at the bank you use for your checking and savings accounts, or you can shop around to other banks for the best interest rates and terms. If you don’t have the time to shop around yourself, you can work with a mortgage broker, who sifts through different lenders to negotiate the best deal for you. Banks aren’t the only source of mortgages, though: Credit unions, some pension funds and various government agencies also offer mortgages.
History of Mortgages
You may think mortgages have been around for hundreds of years — after all, how could anyone ever afford to pay for a house outright? It was only in the 1930s, however, that mortgages actually got their start. It may surprise you to learn that banks didn’t forge ahead with this new idea; insurance companies did. These daring insurance companies did this not in the interest of making money through fees and interest charges, but in the hopes of gaining ownership of properties if borrowers failed to keep up with the payments.
It wasn’t until 1934 that modern mortgages came into being. The Federal Housing Administration (FHA) played a critical role. In order to help pull the country out of the Great Depression, the FHA initiated a new type of mortgage aimed at the folks who couldn’t get mortgages under the existing programs. At that time, only four in 10 households owned homes. Mortgage loan terms were limited to 50 percent of the property’s market value, and the repayment schedule was spread over three to five years and ended with a balloon payment. An 80 percent loan at that time meant your down payment was 80 percent — not the amount you financed! With loan terms like that, it’s no wonder that most Americans were renters.
The Mortgage Payment
The down payment on a mortgage is the lump sum you pay upfront that reduces the amount of money you have to borrow. You can put as much money down as you want. The traditional amount is 20 percent of the purchasing price, but it’s possible to find mortgages that require as little as 10 percent. The more money you put down, though, the less you have to finance — and the lower your monthly payment will be.
The monthly mortgage payment is composed of the following costs, appropriately known by the acronym PITI: