So you wanna buy a house. Unless you're related to the Rockefellers or a whiz kid entrepreneur that means you're probably going to need a mortgage. In fact the home mortgage is one of the most important loans out there. It allows you to move into a house without requiring a huge amount of capital. As noted in part one of this lesson, Mortgage is an amortizing loan with a long payment term that makes the house you purchase the collateral for the loan. So if you can't pay off the loan, the bank can take possession of your house and sell it to make its money back. When you first apply for a mortgage, there will be many steps before the money gets to your hands. The creditors will do a thorough credit check to ensure your credit history isn't abysmal. And from there, they'll begin to shape the terms of the loan. A very important part of this process is the appraisal. In this step, a professional appraiser will estimate the value of the house you want to mortgage. And in fact, this appraisal is an important part of the system of checks and balances. If you've paid a price way above the appraised value of the property, you probably made a bad deal, and the lender doesn't want any part of that. In fact, a lot of lenders got into trouble when this system of checks and balances failed in the months leading up to the bursting of the housing bubble in 2007. The system failed because the appraisers themselves. Weren't doing their due diligence. They were just rubber stamping properties at the selling price. When the bubble burst and prices dropped, lenders could only sell the foreclosed houses for a loss, and ended up suffering for it. Since that market turmoil, lenders have been very careful about their risk. Appraisers have mostly cleaned up their acts, and you are far more likely to get an appraisal that underestimates the value than one that overestimates the value. Okay, back to our main story. After the property's value has been determined by the appraiser and the lender evaluates your credit history, if it all looks good, you will have to decide between two possible mortgage options. On one hand, you can choose a fixed-rate mortgage meaning that the interest rate on your loan will stay the same throughout the period. Thus, if you get into the loan while mortgage rates are low then you time the economy well and can now reap the benefits of a great interest rate for the period of the loan. Meanwhile the lender bears all the risks that interest rates may rise above your fixed rate and you get to sleep well at night. In contrast, the bank can offer you an adjustable or variable rate mortgage that sometimes starts off with a lower teaser rate to draw you in. But here's a big note of caution. An adjustable rate mortgage is much more of a gambler's loan. While the adjustable rate is tied to the prevailing interest rate at the time, if the interest rates rise over time, so too will your mortgage payments. And if interest rates go sky high and you can't pay your mortgage, note that interest rate have gone as high as 20% or more in the past, you may wind up in foreclosure with no home, bad credit, and the loss of all your original down payment and any more equity you may have in the home. You can see then why lenders like to entice you into adjustable rate mortgages. They basically shift all the risk of rising rates right onto your shoulders, and you may not sleep as well at night. Now here's another big caution flag, because adjustable-rate mortgages tend to have initially slightly lower rates than fixed mortgages, precisely because lenders are assuming a lot less risk. A lot of folks are tempted by adjustable rate mortgages. My advice however is that, if you plan to be in the home for any extended period as opposed to flipping it quickly, you are almost always better off with a fixed-rate mortgage. The reason? You can always refinance a fixed-rate mortgage to take advantage of falling interest rates, and thereby keep the risk on the lenders rather than you. Just what do I mean by refinancing your mortgage? Here's how it works. With a refi, as they say in the biz, you basically trade in your old mortgage for a new one with a lower interest rate, maybe even better terms. And one of the reasons I'm highlighting this is that when you get your original mortgage you should be very, very sure there is no pre-payment penalty that would make the cost of a refi prohibitive. In fact, since mortgages involve relatively large sums of money, even small drops in mortgage rates, as little as half of a percentage point, can save you a nice chunk of change on your monthly payments. So do keep an active eye on interest rates as a homeowner and take control of your financial destiny by using refinancing when the situation warrants. Now, here's one last wrinkle in the mortgage game. Mortgage Insurance. If you want to buy a home and wants to put less than a certain amount down, currently 20% in the United States, the lender will require you to purchase mortgage insurance. And as part of your monthly payments, you'll be required to pay the premiums on that insurance. Of course the advantage of mortgage insurance is that it allows you to buy a home with a smaller down payment. That might get you into your first new home a lot quicker. However, as I warned you in an earlier lesson, if you screw up your credit score through bad behavior, or maybe bad luck. You won't be able to qualify for mortgage insurance. You will be shut out of the home buying market, not least until you accumulate more capital. That's just another reason to keep your web of personal finance cozy and secure. Now on to part three when you're ready, and we'll take a look at some of the other types of loans. [MUSIC]
