What is a mortgage? Definition, types & how it works

Mortgages are loans that you use to purchase real estate. A mortgage is a legal agreement between you and a lender – typically a financial institution – where you can use the money from your loan to purchase property.

When you apply for a mortgage, lenders review your finances as part of the underwriting process. Once you have a mortgage, you make regular payments back to your lender to pay off what you borrowed (your loan principal), plus you pay interest and additional fees over time.

• Down payment: Your down payment is a percentage of your home’s purchase price that you pay immediately at closing. The percentage can vary by loan program and lender based on loan type, credit profile, or property details, and typically ranges from 3% to 20%. The higher your down payment, the lower your mortgage amount. Check with your lender for more information, or read more about how much you need for a down payment.
• Credit score: Your credit score shows your overall creditworthiness based on your credit history, repayments, and debt management. Lenders will review your credit score while determining your loan conditions. Credit scores can range from 300 (poor) to 850 (excellent). Explore ways you may be able to build your credit score.
• DTI: Debt-to-income ratio (DTI) compares your total debt to your gross monthly income, showing lenders your ability to manage your finances and pay back debt.
• Amortization: Amortization is the process of paying back your mortgage in regular installments. Lenders will often provide a mortgage amortization schedule showing how much of your payment goes toward loan principal versus interest over the life of your loan.
• APR: Your annual percentage rate (APR) represents the total yearly cost of borrowing money to buy a home. It combines your interest rate with additional fees, points, and other charges.
• Points: An optional method of prepaid interest that your lender may offer at closing. A point typically costs 1% of your loan amount. Paying points up front can help reduce your APR, lowering your interest rate and monthly payments, depending on how long you keep your mortgage.
• Escrow: Your escrow account is an account your lender uses to collect and manage funds for property taxes and insurance as part of your monthly mortgage payment.

There are a variety of mortgages available for you to consider, based on how your interest is calculated (fixed-rate vs. adjustable-rate loans) and who is issuing or insuring your loan.

Mortgages have their own loan term or designated repayment period. The most common loan terms are 15 and 30 years, but your lender may offer a different loan term based on your loan type or situation.

• 15-year loans allow you to pay down principal more quickly, with the potential to recognize equity faster. Paying down your principal may save money on interest payments, but may create higher monthly mortgage payments than you would have with a 30-year loan.
• 30-year loans are more readily available than 15-year loans and often have lower monthly payments. However, you may not build equity as quickly with a 30-year loan term and may pay more interest over the life of your loan.

As you determine whether you qualify for a mortgage, you may consider shopping around for different lenders and speaking with a representative to understand their requirements. Every lender has its own eligibility criteria for mortgage qualification. Additionally, government-backed loans (i.e., FHA or VA loans) often have different eligibility requirements than conventional loans.

In general, you’ll want to know your credit score and DTI and review your savings for a down payment. These financial details can significantly affect your ability to qualify for a loan and get a competitive interest rate. Read more about the importance of credit, debt, and savings when buying a home.

• Get preapproved: To start, you’ll submit documents to a lender – typically bank statements, tax returns, employment records, and authorization for a credit check. In return, you’ll receive a preapproval letter with an estimated loan amount. Preapproval can help strengthen your position as a buyer and set a realistic budget before shopping for a home.
• Shop for homes: Work with a real estate agent to browse listings and tour homes in your preferred neighborhoods. When you find one you like, your agent can help you submit a purchase offer. Once the seller accepts, you’ll learn the terms of your purchase agreement.
• Apply to one or more lenders: You’ll officially apply and go through the underwriting process, where lenders will verify your income and financial history. As part of the process, your lender will often require an appraisal to help confirm the property’s value. A home inspection is a separate step that may be required or benefit you as a buyer, helping you understand the home’s condition. Once underwriting is complete, you’ll learn about your total loan amount and interest rate.
• Closing: On closing day, you’ll sign the closing paperwork and officially take ownership of your home! You will pay closing costs and your down payment. Closing costs vary based on your loan, property, location, and lender, so review your Loan Estimate and Closing Disclosure carefully. You’ll also receive your mortgage statement, which outlines your monthly payment schedule and expectations.

If you miss or can’t make your recurring mortgage payments, lenders may charge you late fees, and you will likely see an impact on your credit score. If the delinquency continues, your lender may begin the foreclosure process (taking ownership of the home), subject to state law and federal mortgage-servicing rules.

If you are experiencing difficulties making mortgage payments, you can talk to a housing counseling agency to learn about your options. You should also reach out to your lender and explain your situation, as lenders would prefer to keep you in your home rather than going through the foreclosure process.

A mortgage is a crucial piece of the homebuying process that makes homeownership possible for so many people. Do your research by comparing lenders and shopping for the best rates and terms that fit your financial situation. The right mortgage is one you can comfortably manage while still meeting other financial goals. With the right preparation, understanding how the process works can put you in a good position to navigate homeownership with confidence.

If you extend your loan term, you may pay more interest over the life of your loan.

If you are a service member on active duty, an eligible spouse, partner, or dependent, or currently receiving SCRA benefits, please consult with your legal advisor prior to seeking a refinance of your existing mortgage loan. In some cases, a refinance may impact your eligibility for benefits under the Servicemembers Civil Relief Act or applicable state law.