What is a First Mortgage Loan and How Does it Work?

A first mortgage loan is the primary loan used to purchase a home or other piece of real estate It is secured by the property itself and gives the lender first priority claim on the property if the borrower defaults First mortgages make homeownership possible for most buyers by allowing them to finance the purchase over an extended period rather than paying the full price upfront. Here’s a detailed look at what first mortgage loans are, how they work, and their key features.

What is a First Mortgage?

A first mortgage is the initial loan obtained to purchase a property It is referred to as the “first” mortgage because any subsequent loans taken out on the property are subordinate to it

When you get a first mortgage loan to buy a home, the lender places a lien on the property. This gives them a legal claim to take possession of the home if you fail to repay the loan as agreed. The first mortgage lender’s lien takes first priority over any other liens or claims on the property.

First mortgages are the most common way for home buyers to obtain financing. Very few can afford to pay cash for a property outright. A first mortgage spreads the cost out over 15-30 years through regular monthly payments.

How Does a First Mortgage Loan Work?

Here are the basics of how first mortgage loans work

• You apply and go through an approval process to qualify for a specific loan amount based on factors like income, debts, and credit score.

• Once approved, you select a property and make an offer.

• After reaching a purchase agreement, you finalize the first mortgage loan details including rate, term, etc.

• At closing, you sign the mortgage agreement and promissory note.

• The lender provides the agreed purchase funds to complete the sale.

• Legal title passes to you even though the lender holds a lien. You can live in and use the property as your own.

• You begin making monthly mortgage payments to the lender per the loan terms.

• Over time, as you make payments, the loan principal declines and your equity builds.

• When the loan is fully paid off, the lien is removed and you have clear title.

While simple in concept, first mortgages entail detailed legal contracts and processes. It’s important to understand these before committing yourself.

Key Features of a First Mortgage

There are some key features common to most first mortgage loans:

Secured Loan: The first mortgage loan is secured by the property itself. This gives lenders recourse if you default. The property can be seized and sold to satisfy the unpaid loan.

Priority Position: The first mortgage lender has first claim on the sale proceeds if the home is foreclosed on. This primes any subsequent, junior liens.

Drawn Down Over Time: You don’t receive the full loan amount upfront. The funds are disbursed over time as construction progresses for a new home build.

Long Term: First mortgages typically have 15-30 year loan terms. This allows for affordable monthly payments.

Fixed or Adjustable Rates: The interest rate may be fixed for the full term, or adjustable periodically based on market rate changes.

Monthly Installments: You make principal and interest payments each month over the life of the loan. Taxes and insurance are often included too.

Prepayment Allowed: You can pay extra to pay the loan off early without penalty. However, prepaying an adjustable rate mortgage may incur fees.

Assumable: Someone buying the property from you can take over the existing first mortgage loan, if allowed by the lender.

Default and Foreclosure: Failing to make payments can result in the lender foreclosing on the property to recoup loan proceeds.

Common Types of First Mortgage Loans

While all first mortgages share the above features, there are several common types and programs:

• Conventional Loans – Offered by private lenders like banks without government backing. Typically require at least 5-20% down payment.

• FHA Loans – Insured by the Federal Housing Administration for lower down payments as low as 3.5%.

• VA Loans – Provided by private lenders but guaranteed by the Dept. of Veterans Affairs for eligible service members. No down payment required.

• USDA Loans – Backed by the US Department of Agriculture for low income borrowers in rural areas. No down payment needed.

• Jumbo Loans – Offer higher loan amounts above conforming limits for pricier properties. Generally have stricter requirements.

• Construction Loans – Short term financing for new home construction then converted to permanent mortgages after completion.

How is a First Mortgage Loan Different from Other Loans?

There are a few key differences between a first mortgage loan and other types of property loans:

• A first mortgage is used for an initial purchase, while a later home equity loan or home equity line of credit (HELOC) uses existing equity as collateral.

• As the primary loan, a first mortgage takes priority over second mortgages or other junior liens if foreclosure occurs.

• First mortgages tend to have lower interest rates than second mortgages or home equity loans.

• First mortgages have set repayment schedules while HELOCs allow flexible draw and repayment of approved credit amounts.

• First mortgages require rigorous underwriting and approval prior to home purchase. HELOCs or home equity loans have easier access to approved credit limits.

Pros and Cons of First Mortgage Loans

First mortgage loans offer major advantages but also some potential drawbacks to consider:

Pros

• Allow borrowers to buy real estate with a small down payment and extended repayment term

• Typically have lower, fixed interest rates for stability

• Interest payments and property taxes are tax deductible

• Can build your net worth and equity as you pay down the loan

• Provide access to special lower rate programs like FHA, VA, and USDA loans

Cons

• Require substantial paperwork and stringent approval process

• Have high costs including origination fees, closing costs, and other charges

• Monthly payments are a long-term commitment that impacts your budget

• You can lose the home if you fail to repay the loan as agreed

• Prepayment penalties may apply on some loan types if you pay off early

The Bottom Line

A first mortgage loan makes it feasible for the majority of home buyers to finance the purchase of their property over time. It provides access to homeownership that would otherwise be out of reach for many. While the approval process can be demanding, having a detailed understanding of how first mortgages work and managing the payments responsibly can lead to a big payoff as you build home equity and wealth over time.