Mortgage loan is a loan secured use to finance by real property. It is usually used with specified payment periods and interest rates according to the agreement of the mortgage loan made between the two parties. Mortgage loan also can know as amortized loan. Under legal agreement, the mortgagor (borrower) gives the mortgagee (lender) a lien on the real estate as collateral for the loan. However, the home loan and mortgage are often used interchangeably. So, the mortgage is really an agreement that makes the home loan work- the commercial bank would not lend you some hundreds of thousands of money unless they knew they could claim your home in the event of your default. Generally, the word mortgage is most commonly used to mean mortgage loan. Besides that, a mortgagor can obtain the financing to buy or secure against the property from a financial institution for instance, a bank, can either directly or indirectly through intermediaries.
On the other hand, there are many types of mortgages which are widely being used in the world. For example, fixed rate mortgage (FRM), adjustable rate mortgage (ARM), equity loan, budget loan, flexible mortgage, balloon loan and others. All of the interest, term, payment amount and frequency, as well as repayment of the mortgage loan may be subject to local regulation and legal requirements. Interest may be fixed by the life of the loan and change at the certain pre-defined periods; the interest rate can also be higher or lowers which is controlled by the mortgage company. Second is term, mortgage loan normally have a maximum term that is the number of the years after which a mortising loan will be repaid. Third is payment amount and frequency, which is the amount and frequency of the payment the mortgagee should pay to the mortgagor. Other than that, some of the amount paid per period may change or the mortgagor (borrower) may have the option to increase or decrease the amount paid.
Furthermore, types of the mortgages may restrict prepayment of all or a portion of the loan, or may require payment of a penalty to the mortgagee (lender) for the prepayment. There are two basic types of mortgage loans which is the fixed rate mortgage (FRM) and Adjustable Rate Mortgage (ARM). Fixed rate mortgage (FRM) also called as a conventional mortgage is a mortgage mean the interest rate and the periodic of payment does not change during the whole term of the loan. For the fixed rate mortgage, payment for principal and interest should not change entire the life of the loan. Fixed rate mortgage than interest rate and the periodic payment does not change but the amount paid by the mortgagor every month that ensure that the loan is paid off in full with the interest at the end of its loan term.
Besides that, the other types of the mortgage loan that can be applied is Adjustable Rate Mortgage (ARM) also known as a floating rate or variable rate mortgage. Adjustable rate mortgage mean a mortgage interest rate that may change, normally response to change in the Treasury bill rate or the prime rate. The interest rate adjustment is primarily to bring the interest rate on the mortgage in line with market rates. The borrower is protected by a maximum interest rate known as a ceiling, which might be reset annually. When the interest rate change, the adjustable rate mortgage monthly payments increase or decrease at intervals determined by the lender. Adjustable rate mortgage loans usually have initial lower market interest rate in the return for the borrower sharing the risk but eventually the interest rate may be increase during the life of the loan. Other type of amortized loan is balloon loan, which is also known as a balloon note or bullet loan. Balloon loan is a long term loan that has a large balloon payment due to upon maturity. Balloon loan have very low interest rate payment and requiring very little capital outlay during the life of the loan. The main disadvantage of the balloon loan is the mortgagor needs to be self disciplined to preparing the large single payment, when the interim payment is not being made by the mortgagee.
1.2 Background of mortgage loan
The mortgage loan is originated in Prussia in 1769, a Danish act on mortgage loan credit associations of 1850 allowed the issuing of bonds as a means to refinance mortgage loans. In line with the German mortgage banks law of 1900, the whole German Empire was given a standardized legal foundation for the emission of Pfandbriefe which eventually an account from the perspective of development economics is available. In the early 1980s, several types of new mortgage loan is created and had were gaining in popularity such as adjustable-rate, option adjustable-rate, balloon payment and interest-only mortgages. These new types of loan are credited with the purpose of replacing the long standing practice of banks making conventional fixed-rate and amortizing mortgages.
2.0 Literature Review of Mortgage Loan
Among the types of mortgage loans, the most regularly used mortgage loan are fixed rate mortgage (FRM) and adjustable rate mortgage (ARM). The first type is the fixed rate mortgage (FRM) is the interest rate does not change during the whole term of the loan. Second type of the mortgage loan is adjustable rate mortgage (ARM) is the interest rate can be changed depending to the situation of the economy. For instance, when the economy is expansion then the interest rate will increase.
2.1 The factors that affect the approval of mortgage loan
In order before for us to get approval of mortgage loan from the banks, there are some aspects that are needed to be considered which an outstanding debt is the most important part to get approval of the mortgage loan from the banks. The bank might decide whether the person will get the mortgage loan or not, if the person who still have thousand dollars of debts on them such as car loan, credit card , home loan and others. So, there is a higher probability the bank may not pass the mortgage loan to this typical applier. There have only one way to solve this type of problem which is that applier must clear off all the outstanding debts before one could be consider qualify to apply mortgage loan.
Second factors are credit cards. Nowadays, money notes are replaced by credit cards, so many people are spending their plastic money which is credit card when purchasing goods or services. Therefore, they always have a thought in their mind that is buy it now and pay it later. As a result, it will affect you apply the mortgage loan. Besides that, before you apply mortgage loan you should not apply too many new credit cards because it will make the banker wonder about your financial situation and hold your application form.
The third factors are credit report. Credit report is like a financial statement which commonly used to record personal or individual past borrowing and paying the outstanding debts. Credit report also is an important factor that affects the approval of the mortgage loan. This is because if the person has a strong credit report then he would be easier to get approved from the mortgage company for his mortgage loan. Besides that, if before you do not obtain a strong credit report, make sure that you must settle your debt off first before you apply the mortgage loan.
Last but not least, Capital also is the factor that will affect the approver of the mortgage loan. Before you apply the mortgage loan, you need to consider the all of the costs included such as the closing costs and the down payments. After that, you must make sure that there is enough capital in your saving account before applying the mortgage loan. If you have insufficient capital and still apply for mortgage loan eventually your application will be rejected by the mortgage company. So, one must make sure that he/she has a fixed capital or fixed income to raise your own capital in yours saving account in order to apply mortgage loan.
2.2 How to avoid the mortgage loan?
One best way to avoid or prevent the mortgage loan is to create a budget and do not stretch yourself too far. People always cannot predict what will happen in tomorrow. So you need to build a detail budget of capital and expenses in order to make sure you can face the financial crisis if the economy is having a recession. If you have a sufficient capital when the economy was unexpected downturn, it is better that at least you have already build a detail budget capital to help you face the crisis. The second way is all the borrower need to be careful with the adjustable rate mortgage. Because these type of the loan can let the mortgagor to bear more interest and pay more money. Adjustable rate mortgage is the interest rate might change depend the market situation. Thus, make sure you have enough budget of capital to pay all those loans and payment. Third effective way to avoid the mortgage loan is don’t jump to refinance your home to pay off the credit card debt. Nowadays, many people used their credit cards to refinancing their homes. But this is not the best way to clean all the debt and to save your home. This might be a risk. As when you do so, the money you spent by credit cards are making you need to pay more interest on the credit card companies. If you are unaffordable to pay the home loan payments, then you should sell out your house and may think of renting a house instead of buying it by yourself.
2.3 What is the mortgage loan qualification?
In order to get the mortgage loan approval we need to know what is the mortgage loan qualification. First the mortgage loan qualification is the down payment. The down payment is the important element for the qualification because banker wants to know how much the down payment to the overall cost of the home. This percentage is known as your loan-to-value (LTV) ratio.
LTV ratio / amount you asking to borrow by the value of the home
The best LTV ratio is 80 % or less.
If higher LTV ration more than 80%, you need to pay for the private mortgage insurance.
Next, the second qualification of mortgage loan is limited debts. Make sure your monthly home cost plus monthly debt payment like car loan, credit cards bill and others cannot be greater than 36% of your gross income if you are going to apply a mortgage loan. Banker will compare with the debt-to-income ratio to determine how much amount you can afford to borrow.
The third qualification is credit history. Credit history played an important role in this part. This is because banker will check and see your credit history to determine how much to approval to you the mortgage loan. Banker will also look at your credit report, so make sure that your credit report does not have any errors. Lenders will use the credit score to borrow the mortgage loan to you.
If your credit score is 720 or higher you should earn most favorable interest rate.
If below the 720 but above 675, you may no longer be approved for the best rate, then you still can find a good loan as well.
If score below 620 may difficult to find a loan with the lower interest rate.
Last but not least, the final qualification is employment record. Most lenders will look into your job history to determine the qualification for the mortgage loan. Lenders are more favorably approve the mortgage loan to who someone was keeping the same job more than 2 years. If the borrower is self-employed or work on a commission, banker will require borrower more about the financial position and the business tax return to consider the qualification status.
3.0 Case study
3.1 A research study of customers preferences in Greece home loan market
In this new era, the various banking systems have undergone drastic changes globally. Because of competition among banks, banks focus on mortgage products in order to satisfy their clients’ needs. In Greece, banks adopted strategy that not only covers and meets all requirements and needs of bank clients, but also provides innovation to those products that attract clients. Mortgage loans issued mostly involves house purchase. The study says that the low interest rates along with the offering of new, products have lead to an increase in demand relating to housing. Clients nowadays are smarter than the previous years. They tend to seek for lower borrowing interest rates which make them turn easily to other banks.
The main purpose of this research is to study the customers’ behavior toward obtaining a home loan in terms of mortgage loan , customers’ use of information sources when choosing a home loan, the choice criteria used by customers to choose a financial institution and the choice criteria used by consumers to choose a home loan. The research data is collected by questionnaires during face-to- face interview. Based on a past literature study by Clarkson et al. (1990), suggest that the characteristics and financial service requirements of consumers vary with age and that these differences could be used in developing marketing strategies for such service .This is true because based on this study, the highest percentage of bank customers are between 31 to 40 years of age and the lowest is 21 years old and below. We can conclude here is that the banks’ main customers are mostly middle age and we can explain that people at this age are their highest working performance and earning the highest income.
Now, let us look at the factors that affect the selection of banking institutions for mortgage loans. In this sense, interest rate is considered to be the utmost criteria in the selection of bank.
Below is the statistic of interest rate based on the research carried out:
Interest rate is an important component for mortgage loan as it is a financial charge for use of the lenders’ money. In the paper of W.Bpyd et al. (1994) the results of the study reveal that reputation, interest charged on loans, and interest on savings accounts are viewed as having more importance than other criteria such as friendliness of employees, modern facilities and drive-in-service. Interest-only mortgages is a popular way for homeowners to take advantage of a cheaper and more affordable mortgage option. Lower interest rate means that, paying lower mortgage loan, which is affordable by everybody to own a house by themselves. But on the other hand, the disadvantage of interest only mortgage loan is after a few years the loan holder will have the money to refinance or pay of the mortgage in a lump sum and the loan holders may face difficulties in terms of financial problems.
4.0 Calculation of Mortgage Loan
4.1 Examples in Calculating Mortgage Loan
Mortgage loan calculations are based on present value concepts.
Present Value Basics
Example 1: A borrower obtains a $100,000, 10 percent, 25 year loan. Repayment of this loan requires 25 annual payments of $11,017. To count the present value, we can use this formula.
Annual payment x Annuity factor = Present Value of Payments
$11,017 x 9.077 = $ 100,000
These terms can be rearranged to calculate the loan payment :
Loan amount x Mortgage constant = Annual payment
$100,000 x 0.11017 = $11,017
Now, let us estimate a mortgage’s unpaid balance as of a certain date.
Example 2: Assume a $ 50,000 loan was made for 25 years at an 8 percent rate. The appropriate mortgage constant is 0.0937 and the annual payment is $ 4,685.
Loan amount x mortgage constant = Annual payment
$50,000 x 0.0937 = $ 4,685
Consider that the loan is still an annuity but has only 18 remaining annual payments. What is the unpaid balance of the loan after 7 payments have been made? To find the unpaid balance, the present value of the annuity is calculated using the annuity factor for 8 percent and 18 years.
Annual payment x Annuity factor = Unpaid balance
$ 4,685 x 9.372 = $ 43,907.82
Now, let assume that if the owner desires to sell the mortgage after receiving the 7th payment.
Example 3: Assume the current mortgage rate for this type of loan is 12 percent. Again, the mortgage is an annuity with 18 current market price of the mortgage, the payments are discounted using the annuity factor for 12 percent and 18 years.
Annual payment x Annuity factor = Market Value
$ 4,685 x 7.250 = $ 33,966.25
The decreased value of the mortgage results from the fact that the fixed payments must provide a higher rate of return to the owner of the mortgage than is provided in the mortgage, i.e, 12 percent versus 8 percent.
Figure 1 : Illustration of a declining-balance mortgage loan
Loan amount : $ 100,000
Interest rate : 11%
Term : 10 years
Mortgage constant : 0.1698014
Payment : $ 16,980.14
|1||$ 16,980.14||$11,000.00||$ 5,980.14||$ 94,019.86|
With mortgages, we want to find the monthly payment required to totally pay down a borrowed principal over the course a number of payments. The standard mortgage formula is:
M = P [ i(1 + i)n ] / [ (1 + i)n – 1]
M = Monthly payment
P = Interest payment
I = interest rate
N = number of years
Example 4: $100,000 mortgage at 5% compounded monthly for 15 years, we first solve for i as
i = 0.05 / 12 = 0.004167 and n as 12 x 15 = 180 monthly payments
Next we would solve for (1 + i)n = (1.004167)180 using the xy key on the calculator, which yields 2.11383
Now our formula reads M = P [ i(2.11383)] / [ 2.11383- 1] which simplifies to
M = P [.004167 x 2.11383] / 1.11383 or
M = $100,000 x 0.00790 = $790.81
So, the monthly payment is $ 790.81.
In summary, mortgage or commonly recognized as mortgage loan is one of the important topic in corporate finance. It is a secured loan to help people to finance their properties. In return, interests and fixed payments are needed by the mortgagors to pay to the mortgagees. It might take few months or few years for the mortgagors to keep on paying the payments until the total amount of mortgage loan is clear or pay off. The agreement is made between the two parties which are the borrower and the lender. When the borrower has determined the qualification and the background of the applicant, which is the lender and satisfy of the overall condition of the applicant and finally approved the application of mortgage loan. The payment includes the interest rate, term, payment amount as well as the frequency of the payment should be made by the lender. The most common types of mortgage loans among the mortgage industry are fixed rate mortgage and adjustable rate mortgage.
Besides that, we have also discussed about a few factors which will affect the approval of the mortgage loan application. This is important for the borrower in order to avoid wastage of time, problems and energy to apply the loan all over again when it is being rejected back by the mortgage company. So one must carefully check and understand his/her financial ability and make sure that there are no high outstanding debts, over credit cards usage and has proper income sources before apply for mortgage loan. Other than that, the qualification of a mortgage loan is being discussed too. Many are confuse and doubt about how to get an approval for their mortgage loan application. We have made some research for the factors to be qualified for a mortgage loan. The factors affecting the qualification as a mortgagor are the down payment amount of the mortgage loan, the condition of limited debts, credit history as well as the employment record. One is considered as a qualified borrower when he or she has fulfilled these criteria and the lender will consider approving the application of mortgage loan.
Last but not least, we have included some simple yet understandable example to calculate the mortgage loan by using the mortgage loan formula. We made various assumptions and calculate the answer for each example. On the other hand, we can know the monthly payment required to pay by applying the standard mortgage formula. The mortgage loan calculations are based on present value concepts. Mortgage loan can be helpful and beneficial to the borrower if they manage it well.