Buying a home is the biggest investment for most people during their lifetime and going for mortgage loans is the norm to arrange for finances at affordable terms. Since it is possible to customize mortgage loans according to the needs of borrowers, it becomes affordable for all which is the reason why it is so popular. The property that you are buying becomes the collateral for securing the loan, and it is a big relief for borrowers who need not arrange for other collateral that could be difficult for them.
Before taking out a loan for buying a home, you must be ready to make some down payment to the tune of 10%-20% of the total cost of the property and must be comfortable with the monthly payment that fits your budget. While the lending company will decide on a standard monthly payment based on the loan amount, interest rate and the tenure of the loan you can try out various combinations by altering the factors to see if any better monthly payment is possible. To facilitate the calculation, you can use Karl’s old mortgage calculator that can work out various repayment options based on your choice of the loan term, interest rate and loan amount.
Mortgage loans have their advantages and disadvantages but considering that most people use it as a primary means of home finance, the indications are clear that the advantages are surely greater than the disadvantages. However, you need to know about both so that instead of just following the trend you can take a well-informed decision.
Now let us look at the advantages.
When you take a mortgage loan, you get the benefit of leveraging your investment which is the down payment that you make. Look at some simple arithmetic to understand how you benefit from the appreciation of property value. Suppose, you buy a home for $700,000 and take a loan of $600,000 while making down payment of $100,000. If the property appreciates by 10% over a year, it amounts to $75,000 that translates into 75% return on your investment of $100,000. This is what in financial parlance is called leverage. On the other hand, had you paid all cash for buying the property your gain after one year would be equal to 10% only, equivalent to the rate of appreciation. It means that when you take out a mortgage loan you can make money by using the borrowed money and it can increase the rate of appreciation up to five times.
Homeownership with minimal payment
One of the biggest advantages of mortgage loans is that you become the owner of the property without having to make the full payment from your pocket. Just imagine that by making a down payment of only a fraction of the property value you can own the property but with the condition that in case of not paying back the loan you would lose the ownership and the property. While 10% -20% is the prevailing rate of down payment, it can be as low as 3.5% for those availing FHA of Federal Housing Administration-insured loans.
Buying a home with mortgage loan frees up your money that you can use for some other purposes and multiply it faster by availing opportunities of investments in other areas. Home equity loans which are a kind of mortgage loan are useful for home remodeling projects, repairs or home improvements.
Mortgage interest deduction
Mortgage loans come with a tax-deductible element like anyone availing the loan qualifies for tax benefit on the interest paid. The extent of the deduction depends on your total income that determines the tax bracket to which you belong and the amount of interest. The same kind of benefit is available from home equity loans which are similar to mortgage loans but with the difference that it is for home improvement only and not for buying homes. You can avail a full deduction of interest up to a certain limit which can be as high as $750,000.
Taking a mortgage loan gives you a sense of security since you pay a small amount from your pocket while owning the home by using the loan. As you have cash in the bank, it enhances the security and you have opportunities of using that money to make it grow faster. Assuming that you have comprehensive home insurance and in the event, the home is damaged or destroyed due to an earthquake, for example, the insurance company would help to rebuild your home. Even in case some other emergency crops up in between, the risks of the property rests on the lender, and you do not worry about the liabilities arising from it. Life is full of uncertainties, and an economic crisis can crop up any moment, but when you have a mortgage loan, you can have a steady bankroll to encounter any unforeseen financial needs with confidence.
Improved credit rating
Taking a mortgage loan allows you to improve the credit score as you make regular payments. The credit score is very important because it reflects your creditworthiness that lenders use to determine the risks associated with lending money to you and determines the interest rate accordingly. When you have a good credit score, it means that you can qualify for a lower interest on other credit products like a credit card loan or car loan. When you are looking for additional credit, lenders would look at your mortgage payments to see how regular you are in making payments.
The only risk of a mortgage payment is that you can lose the house in case you fail to make payments. Since the house is collateral for the loan, the lender has every right to take it back should you falter. If it happens, you even lose all the money paid up to that time.
If the home loses its value over time, which is possible because not all reasons are within your control, it will be like a penalty on you because the mortgage payment remains unchanged. As a result, your mortgage payment will be more than the home value.