How does a mortgage work?

March 14, 2017

 

Essentially a mortgage is an agreement with a bank and a borrower to lend money so that the borrower may buy a property; where the property being purchased is used as security for the money being borrowed.

 

Instead of paying for a home with cash, which most of us cannot afford to do, the borrower pays a portion in cash (typically 25%) and takes out a mortgage for the balance. To put it another way, a mortgage is a type of debt instrument, that uses a specific piece of real estate as security (collateral) for the money being borrowed; where borrower is legally obligated to repay with a predetermined set of payments; usually monthly.

 

Interest is calculated daily on the outstanding balance and charged monthly. Interest rates can either be “variable” (which change with market conditions) or “fixed”. Fixed rates of 1 to 5 years are generally available from most lenders.

 

Mortgages are used by individuals and businesses to purchase various types of residential and commercial property. A mortgage enables a purchaser to acquire the property without needing to pay the entire cost of the property in cash upfront. The borrower either repays the loan, plus interest, usually over a period of many years until the mortgage is cleared and the property becomes “unencumbered” (debt free); or on-sells the property before the loan term expires and uses the funds from the sale to clear the mortgage in a single payment.

 

As most properties in capital cities around the world on average double in value every ten years or so, the purchaser knows that if they can afford to make the repayments for a number of years, there is a good chance that the property will increase in value and that their “equity” within the property (the part in which they own) will increase.  

 

In the UAE the maximum loan term allowed is 25 years for salaried people up to the age of 65 and self employed up to the age of 70.  The lengthy term allows mortgage payments to be affordable and manageable. Also see how much can I borrow?


 

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