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 upfront and annually, over the course 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 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
- USDA 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 loans are mortgage loans guaranteed by the U.S. Department of Agriculture (USDA). They’re only available on properties located in designated rural parts of the country. They require no down payment, but you’ll have to pay mortgage insurance premiums, both upfront and annually.
See if your property is eligible with the USDA's tool.
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.
Also in 2016, 6% chose 15-year fixed-rate mortgages, 2% chose adjustable-rate mortgages, and 2% opted for other loan terms.
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 vs. 15-Year Mortgages
|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|
|May be easier to buy the home you want||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 vs. Adjustable-Rate Mortgages
|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|
Qualifying for a Mortgage
Every loan program has unique eligibility requirements. Here’s what the country’s most popular loan programs require:
- 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.
U.S. Department of Housing and Urban Development. "Minimum Credit Scores and Loan-to-Value Ratios." Accessed May 28, 2020.
U.S. Department of Housing and Urban Development. "FHA’s Impact on Increasing Homeownership Opportunities For Low-Income and Minority Families." Accessed May 28, 2020.
EllieMae. "July 2019 Origination Insight Report." Accessed May 28, 2020.
Consumer Financial Protection Bureau. "Determine Your Down Payment." Accessed May 28, 2020.
Consumer Financial Protection Bureau. "Special Loan Programs." Accessed May 28, 2020.
Freddie Mac. "Why America's Homebuyers & Communities Rely on the 30-Year Fixed-Rate Mortgage." Accessed May 28, 2020.
Consumer Financial Protection Bureau. "Understand Loan Options." Accessed May 28, 2020.
Fannie Mae. "General Requirements for Credit Scores." Accessed May 28, 2020.
U.S. Department of Veteran Affairs. "VA Guaranteed Loan." Accessed May 28, 2020.
USDA Rural Development. "Direct Loan Program Credit Requirements." Accessed May 28, 2020.