What Is a Mortgage?
Get the scoop on the loan you'll likely need to buy a home.
A mortgage is a specific type of loan that’s used to purchase a home or piece of property. They’re offered by banks, credit unions, and other financial institutions across the country.
When you use a mortgage to purchase your house, your lender—the bank or institution loaning you the funds—actually pays for the home outright. Then, over the length of your loan, you pay the lender back for those funds, plus interest, month after month.
A mortgage loan is a secured loan, meaning you are borrowing against the value of an asset--in this case, your home. Should you fail to repay the loan, your lender has the right to take the property. Once the loan is completely paid off, your lender can no longer claim your home.
While the concept of a mortgage is fairly simple, there are many different types. Mortgages may have shorter or longer repayment terms, interest rates that stay the same or vary over time, and 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. Here is an overview of the key distinctions.
Types of Mortgage Loans
There are several types of loan products you can choose from, each with their own eligibility and down payment requirements. Common types include:
FHA Mortgage Loans
These are loans backed by the Federal Housing Administration. They require as little as a 3.5% down payment and allow for credit scores as low as 500. They also require you to pay a premium for mortgage insurance, both up front and annually, over the course of the loan. About a 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 loan product, accounting for the majority of U.S. loans originated every month. Though they come with fewer fees than FHA loans, they also have more stringent credit and debt-to-income requirements. Down payment requirements vary widely, generally 3% to 20%.
Other Government-Backed Loans
There are other special loan programs for certain types of buyers:
- VA mortgage loans
VA loans are insured by the Department of Veterans Affairs and are available only to military members, veterans, and surviving spouses of these parties. 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 mortgage loans
These are mortgage loans guaranteed by the U.S. Department of Agriculture. They’re only available on properties located in designated rural parts of the country. (Use this tool to see if a property is eligible.) They require no down payment, but you’ll have to pay mortgage insurance premiums, both up front and annually.
The Terms of a Mortgage
Mortgage loans diverge on their “term”—meaning how long you have to repay the loan.
The most common mortgage term is 30 years. In 2016, 90% of homebuyers chose a 30-year fixed-rate mortgage, according to the most recent data available from Freddie Mac. In the same year, 6% chose 15-year fixed-rate mortgages, 2% chose adjustable rate mortgages, and 2% opted for other loan terms. (There’s more on fixed- and adjustable-rate loans below.)
Shorter-term loans allow you to pay off your loan faster and with less interest, but they also require higher monthly payments. Longer-term loans mean a lower monthly payment, though the longer pay-off period (and typically higher rate) usually equals more interest paid over time . The best option depends on your budget and how long you plan to stay in the home.
30-year term: Pros
Lower monthly payments
May be easier to buy the home you want
30-year term: Cons
Higher interest rates
Slower loan payoff
More interest paid over time
15-year term: Pros
Lower interest rates
Quicker loan payoff
Less interest paid over time
15-year term: Cons
Higher monthly payments
May be difficult to afford the home you want
Fixed vs. Adjustable Rates
Mortgages also vary by interest rate type. As the name suggests, fixed-rate loans come with set, consistent interest rates for the entirety of the loan term. That means you’ll always pay the same amount of interest each month until your home is fully paid off.
Adjustable-rate loans, on the other hand, have variable interest rates. They come with a set interest rate for a short period of time (often three, five, seven, or 10 years), after which the rate can increase. This means an increased monthly payment as well.
Adjustable-rate loans typically come with much lower interest rates, initially, than fixed-rate options, 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: Pros
No risk of an interest rate increase
Predictable monthly payments
Easy to budget and plan for
Good for long-term homeowners
Fixed-rate mortgage: Cons
Higher interest rates, at least initially
May be harder to afford the home you want
Adjustable-rate mortgage: Pros
Lower interest rates, initially
Lower monthly payment, initially
Higher debt-to-income allowed
Good for short-term homeowners
Adjustable-rate mortgage: Cons
Risk of an interest-rate increase later on
Unpredictable payments after a certain point
Risky for long-term homeowners
Qualifying for a Mortgage
Every loan program has unique eligibility requirements. Here’s what the country’s most popular loan programs require as of 2019:
FHA Loans :
- 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: Depends, but generally above 640
- Down payment: None
- Debt-to-income ratio: 41%
Individual mortgage lenders may have additional or more stringent requirements, so make sure to talk to your lender about the standards you need to meet in order to qualify.
Shopping Around for a Mortgage
In addition to the differences between individual mortgage products, there are also differences among lenders—especially 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, as this will impact your up-front and long-term costs as well.
Consumer Financial Protection Bureau: What is a mortgage?
Housing and Urban Development: FHA’s Impact on Increasing Homeownership Opportunities For Low-Income and Minority Families
Ellie Mae: July 2019 Origination Insight Report
Consumer Financial Protection Bureau, Determine Your Down Payment
Consumer Financial Protection Bureau, Special Loan Programs
Freddie Mac. "Why America's Homebuyers & Communities Rely on the 30-Year Fixed-Rate Mortgage," Accessed Oct. 23, 2019.
Consumer Financial Protection Bureau, Understand Loan Options
Consumer Financial Protection Bureau: What is the difference between a fixed-rate and adjustable-rate mortgage (ARM) loan?
Department of Housing and Urban Development: "Minimum credit scores and loan-tovalue (LTV) ratio requirements for FHA-insured loans" Accessed Oct 30, 2019
Fannie Mae: General Requirements for Credit Scores
Consumer Financial Protection Bureau: "What is a debt to income ratio?"
Department of Veteran Affairs: "VA Guaranteed Loan, Key Underwriting Criteria" Accessed Oct 30, 2019
USDA Rural Development, "Direct Loan Program Credit Requirements." Accessed Oct 30, 2019