If you're going to be responsible for paying a mortgage for the next 30 years, you should know exactly what a mortgage is. A mortgage has three basic parts: a down payment, monthly payments and fees. Since mortgages usually involve a long-term payment plan, it's important to understand how they work.
A mortgage has three parts: a down payment, monthly payments and fees.
Types of Mortgages
There are two main types of mortgages: conventional and Islamic.
After you choose your loan, you’ll decide whether you want a fixed or variable rate. Your choice determines the interest you’ll be charged.
A fixed rate mortgage requires a monthly payment that is the same amount throughout the term of the loan. When you sign the loan papers, you agree on an interest rate and that rate never changes. This is the best type of loan if interest rates are low when you get a mortgage.
A variable rate loan allows the interest rate on your loan to vary with prevailing interest rates. If rates go up, so will your mortgage rate and monthly payment. If rates increase a lot, you could be in big trouble. If rates go down, your mortgage rate will drop and so will your monthly payment. It is generally safest to stick with a fixed rate loan to safeguard against rising interest rates. If rates drop, refinance your mortgage to take advantage of lower rates.
Murabaha: Murabaha is an Islamic financing structure in which an intermediary buys a property with free and clear title. In a murabaha contract of sale, the bank buys a property from a client for a predetermined profit over the cost of the item, then sells the item back to the client in installments. Because a set fee is charged rather than riba, or interest, this type of loan is legal in Islamic countries. Islamic banks are not authorized to charge interest on loans because of religious beliefs, so banks must charge a flat fee for continuing daily operations.
Ijarah: Ijarah means “providing services and goods temporarily for a wage.” The main difference between Ijara and Murabaha is that with an Ijara mortgage, the property will not immediately be registered as belonging to you. Instead, you will essentially rent the property from your lender. In addition to the agreed monthly repayment amounts, you will also pay monthly rent to the bank. At the end of the agreed term or once the purchase price has been repaid in full, ownership of the property is transferred from the lender to you.
The interest rate that you are quoted at the time of your mortgage application can change by the time you sign your home loan. If you want to avoid any surprises, you can pay for a rate lock, which commits the lender to giving you the original interest rate. This guarantee of a fixed interest rate on a mortgage is only possible if a loan is closed in a specified time period, typically 30 to 60 days. The longer you keep your rate lock past 60 days, the more it will cost you. Rate locks come in various forms – a percentage of your mortgage amount, a flat one-time fee, or simply an amount figured into your interest rate. You can lock in a rate when you see one you want – when you first apply for the loan or later in the process. While rate locks typically prevent your interest rate from rising, they can also keep it from going down. You can seek out loans that offer a “float down” policy where your rate can fall with the market, but not rise. A rate lock is worthwhile if an unexpected increase in the interest rate will put your mortgage out of reach.
A lender may require you to pay for private mortgage insurance, which protects the lender's liability if you default, allowing them to issue mortgages to someone with lower down payments. The cost of insurance is based on the size of the loan you are applying for, your down payment and your credit score.