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LESSON 2: HOW MORTGAGES
WORK
A mortgage is a long-term loan that a borrower
obtains from a bank,
thrift,
independent mortgage broker,
online lender or even the property seller. The house and the land
it sits on serve as collateral
for the loan. The borrower signs documents at closing time giving
the lender a lien
against the property. If that borrower doesn't make payments as
agreed, the lender can take the home through foreclosure!
Because mortgages are such large loans, consumers
pay them off over long periods of time -- usually 15 to 30 years.
Their monthly payments gradually whittle away the principal balance.
A
monthly mortgage payment is sometimes called a PITI
payment. That's because each one covers a portion of the following
four costs:
Principal -- the loan balance
Interest -- interest owed on that balance
Real estate Taxes -- taxes assessed by
different government agencies to pay for school construction, fire
department service, etc.
Property Insurance -- insurance coverage
against theft, fire, hurricanes and other disasters
Borrowers can choose to pay their real estate
taxes and insurance in lump sums when they come due, rather than
in monthly installments to their escrow
accounts. We'll talk more about that in Lesson
12. Depending on the kind of mortgage a borrower has, the monthly
payment may also include a separate levy for private mortgage insurance
(PMI) or government-backed mortgage insurance premiums. We cover
that in Lesson
5.
(continued on next page)
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