Loans, Mortgages

Understanding The Basics of Mortgage Loans

mortgage-loanNowadays people are afraid to take loans. This is partly due to uncertain economic situation of the entire world, which may cascade down as job loss, and partly due to the personal impressions about loans. People have possibly burnt their fingers by borrowing heavily, or have seen somebody they knew suffer under the burden of loan installments.

Ironically, we also live in an age where we have more financial options, and can plan our monies to near perfection. There are tools like spreadsheets that enable us to project our financial requirements for several years. Such projection and budgeting helps us identify the years when we would be left with surplus, and the years when our finances will be in red. These software tools also enable us to assess whether we can afford the debt.

Signing for a loan from financial institutions is not such a bad idea. However, it is essential to assess whether you can afford that much borrowing. Many people tend to have a rosy picture about their finances, and are willing to leave things to chance, which is when loans can bring in hardships. Borrowing from financial institutions has several advantages.

  • First and foremost, the loan repayment is structured in such a way that the person can repay the loan easily out of monthly income.
  • Secondly, interest rates are lower when compared to sources of such money in the market.
  • The third reason is that money, when borrowed from friends or relatives often spoils relationships. They may call up the monies due to some exigencies, and the borrower might find it tough to raise the funds at the right time.

The last but not the least is the reduction in value of the monies that are paid in future. Installments payable on loan do not increase as per inflation. Therefore, the purchasing power with such amounts keeps on coming down over the years. This means borrower pays less on the loans, when compared to what he or she may have paid as rent. Though installments might weigh heavily on the minds of the borrower in the initial stages, over a period, they do not cause as much stress because the borrower’s earnings also increase during the loan term.

Loans can be obtained on stocks, real estate, numismatic collections, art collections, vehicles, gold and other bullion, etc. In some cases, loans are offered without any such security. Loans given without security are almost always expensive when compared to other loans. Credit scores are affected by the financial behavior of the person borrowing. So paying loan installments is wise way of managing finances.

Loans are offered on simple or compound interest rates. Borrowings on simple interest are cheaper, but some caution needs to be exercised. This is because some finance companies offer such loans calculating interest for the entire period, on the entire amount of borrowing. Then they add this amount to the borrowed principle, and spread the total equally across the period of repayment. This means that borrower continues to pay interest on part of the loan that he or she has already repaid. They may also collect a few installments upfront, before disbursing the loan. Effectively, the interest rate is higher than what is advertised, and the borrowing becomes rather expensive.

A more complex way of calculating loan repayment has evolved over the years. In this the loan and its interest are spread across several years like the above method. However, interest on such loan products is calculated on what is known as reducing balance method. This means, that part of the loan that is repaid every month is reduced and interest is then calculated on this reduced borrowing. This system is advantageous for both borrowers as well as lenders. Generally, such loans are long term loans, and they are given on some security, i.e., a collateral is necessary to get such loans. Mortgage loans are worked in this way. The process of repayment of loan in regular installments is known as amortization.

There are other options in such loans like second mortgage, loan refinance, and even loan rescheduling. Second mortgage is another mortgage that is taken concurrently with an existing mortgage. It releases any additional equity that may have accumulated on the asset offered as collateral in the interim period. Repayment period of mortgage loans can be anywhere between 10 to 30 years or more. There is bound to be some capital appreciation on any real estate properties that form the security for the mortgage loan. It is this capital appreciation that can be withdrawn with such loans. Loan refinance also releases such additional equity or may be availed to obtain better terms of repayment. Loan rescheduling helps to prevent any foreclosure in case the borrower is unable to adhere to the agreed loan repayment schedule. Spreading the loan across longer term helps in bringing down installment. At times, lenders may be amenable to offering some respite, i.e., the borrower may be allowed to pay only the interest for specified number of years, before the equated installments resume. Some lenders have also allowed borrowers to avail loans in such a way that interest gets added to the principle and repayment starts a few years down the lane. Effectively, the borrowed amount is more. This type of loan is offered on belief that the borrower’s earnings will increase in future. Likewise, if the borrower has some investments which are likely to mature, then lenders allow the borrower to avail larger loans subject to condition that when the amounts are received from such investments, the borrower can repay part of the loan.

A post by Kidal D. (3253 Posts)

Kidal D. is author at LeraBlog. The author's views are entirely his/her own and may not reflect the views and opinions of LeraBlog staff.
Chief editor and author at LERAblog, writing useful articles and HOW TOs on various topics. Particularly interested in topics such as Internet, advertising, SEO, web development, and business.

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