A mortgage is a specific type of loan used to purchase a home or a piece of real property. Mortgages are offered by banks, credit unions, and other financial institutions across the country.
Your lender—the bank or institution loaning you the funds—actually pays for the property outright when you use a mortgage to purchase a home. You then pay those funds back to the lender, plus interest, typically each month over the length of the loan.
What Is a Mortgage?
A mortgage loan is a secured loan. You're borrowing against the value of an asset—in this case, your home. Your lender has the right to take the property should you default and fail to repay the loan. Your lender can no longer claim your home once the loan is completely paid off.
How Does a Mortgage Work?
Mortgages can have shorter or longer repayment terms. They can have interest rates that stay the same or that vary over time, and they can have different criteria for eligibility. Most of these variations have to do with your preferences for repayment terms, as well as the amount of risk assumed by the lender.
Mortgage loans can have different “terms," the length of time you have to repay the loan.
The most common mortgage term is 30 years. According to the most recently published data gathered and published by Freddie Mac, 90% of homebuyers chose a 30-year, fixed-rate mortgage in 2016.
Approximately 6% homebuyers chose 15-year fixed-rate mortgages, while 2% chose adjustable-rate mortgages and 2% opted for other loan terms.
You'll pay off your mortgage faster and pay less in the way of cumulative interest over the life of the loan if you opt for a shorter-term loan, but this means higher monthly payments. Longer-term loans mean a lower monthly payment, but the longer pay-off period and typically higher interest rate usually equals more interest paid over time.
Your best option for a mortgage term generally depends on your budget and how long you plan to stay in the home.
30-Year vs. 15-Year Mortgages
The term of your mortgage can have a significant impact on several loan factors.
|30-Year Mortgage||15-Year Mortgage|
|Higher interest rates||Lower interest rates|
|Lower monthly payments||Higher monthly payments|
|Slower loan payoff||Quicker loan payoff|
|More interest paid over time||Less interest paid over time|
|Might be easier to buy the home you want||Might be difficult to afford the home you want|
Fixed vs. Adjustable Rate Mortgages
Mortgages also vary by the type of interest rate charged. As the name suggests, fixed-rate loans come with set, consistent interest rates for the entirety of the loan term. You’ll always pay the same amount of interest every month until your home is paid off.
Adjustable-rate loans (ARMs) have variable interest rates. They come with a set interest rate for a period of time, usually three, five, seven, or 10 years, after which time the rate can increase. This means an increased monthly payment.
Adjustable-rate loans typically come with much lower interest rates than fixed-rate options initially, but they carry the added risk of future rate increases. ARMs can be a good choice if you know you won’t be in the home long, or if you’re willing to refinance into a fixed-rate loan before your low-rate period expires.
|Fixed-Rate Mortgage||Adjustable-Rate Mortgage|
|Higher interest rates, at least initially||Lower interest rates, initially|
|Predictable monthly payments||Lower monthly payment, initially|
|Easy to budget and plan for||Unpredictable payments after a certain point|
|No risk of an interest rate increase||Risk of an interest-rate increase later on|
|Good for long-term homeowners||Risky for long-term homeowners, better for short-term homeowners|
|May be harder to afford the home you want||Higher debt-to-income allowed|
Types of Mortgage Loans
You can choose from several types of loan products, each with their own eligibility and down-payment requirements.
FHA Mortgage Loans
These loans are backed by the Federal Housing Administration. They require as little as 3.5% for a down payment, and they allow for credit scores as low as 500. They require that you pay a premium for mortgage insurance, both upfront and annually, over the life of the loan.
About one-fifth of U.S. homebuyers opt for an FHA loan.
Conventional Mortgage Loans
Conventional loans are far and away the most popular type of mortgage product, accounting for the majority of U.S. loans originated every month. They come with fewer fees than FHA loans, but they also have more stringent credit and debt-to-income requirements. Down-payment requirements can vary widely, generally from 3% to 20%.
Other Government-Backed Loans
Other special loan programs for certain types of buyers include VA mortgage loans and USDA mortgage loans.
VA loans are insured by the Department of Veterans Affairs and are available only to military members, veterans, and the surviving spouses of these individuals. They require no down payment and no mortgage insurance, and they allow you to roll your closing costs into the balance of the loan.
USDA loans are mortgage loans guaranteed by the U.S. Department of Agriculture. They’re only available to purchase properties located in designated rural areas of the country. They require no down payment, but you’ll have to pay mortgage insurance premiums, both upfront and annually.
Requirements for a Mortgage
Every loan program has its own unique eligibility requirements.
- Credit score: At least 500
- Down payment: 3.5% (with 580 credit score) or 10% (with 500 credit score)
- Debt-to-income ratio: 43% or less (45% allowed in some cases)
- Credit score: 620
- Down payment: 3% (on certain loan programs) or higher, especially for large loans
- Debt-to-income ratio: 43%
- Credit score: No minimum
- Down payment: None (though a funding fee is required and can be rolled into the loan balance)
- Debt-to-income ratio: No maximum
- Credit score: It can depend, but generally above 640
- Down payment: None
- Debt-to-income ratio: 41%
Individual mortgage lenders might have additional or more stringent requirements for these programs, so talk with your potential lender about the standards you must meet to qualify.
Shop Around for a Mortgage
There are also differences among lenders, particularly when it comes to costs.
Mortgage lenders often differ in fees, closing costs, and even the interest rate they’re able to give you, so it’s important to shop around and get several quotes before deciding who will originate your loan. You should also ask about the down payment and any private mortgage insurance you’d be required to pay, because this will impact your upfront and long-term costs as well.
- A mortgage is a loan taken out to purchase a home or other real property.
- A mortgage loan is secured by the property acting as collateral. A lender can seize the property and sell it in the event the borrower defaults on the mortgage’s terms.
- Mortgages can have varying terms, including the number of years it will take to pay them off and interest rates.
- Government-backed mortgage programs can make it easier for some would-be homeowners to borrow.