What Is a Mortgage?
A mortgage is a type of loan used to purchase or maintain a home, land, or other types of real estate. The borrower agrees to pay the lender over time, typically in a series of regular payments that are divided into principal and interest. The property then serves as collateral to secure the loan.
A borrower must apply for a mortgage through their preferred lender and ensure that they meet several requirements, including minimum credit scores and down payments. Mortgage applications go through a rigorous underwriting process before they reach the closing phase. Mortgage types
vary based on the needs of the borrower, such as conventional and fixed-rate loans.
How Mortgages Work
Individuals and businesses use mortgages to buy real estate without paying the entire purchase price up front. The borrower repays the loan plus
the regular payment amount will stay the same, but different proportions of principal vs. interest will be paid over the life of the loan with each
payment. Typical mortgage terms are for 30 or 15 years.
For example, a residential homebuyer pledges their house to their lender, which then has a claim on the property. This ensures the lender’s interest in
use the money from the sale to pay off the mortgage debt.
The Mortgage Process
Would-be borrowers begin the process by applying to one or more mortgage lenders. The lender will ask for evidence that the borrower is capable of repaying the loan. This may include bank and investment statements, recent tax returns, and proof of current employment. The lender will generally
run a credit check as well.
If the application is approved, the lender will offer the borrower a loan of up to a certain amount and at a particular interest rate. Homebuyers can
apply for a mortgage after they have chosen a property to buy or while they are still shopping for one, a process known as pre-approval. Being pre-approved for a mortgage can give buyers an edge in a tight housing market because sellers will know that they have the money to back up their offer.
Once a buyer and seller agree on the terms of their deal, they or their representatives will meet at what’s called a closing. This is when the borrower
makes their down payment to the lender. The seller will transfer ownership of the property to the buyer and receive the agreed-upon sum of money,
and the buyer will sign any remaining mortgage documents. The lender may charge fees for originating the loan (sometimes in the form of points) at
Types of Mortgages
Mortgages come in a variety of forms. The most common types are 30-year and 15-year fixed-rate mortgages. Some mortgage terms are as short as
five years, while others can run 40 years or longer. Stretching payments over more years may reduce the monthly payment, but it also increases the total amount of interest that the borrower pays over the life of the loan.
credit scores, or down payments required to qualify for conventional mortgages.
The following are just a few examples of some of the most popular types of mortgage loans available to borrowers.
borrower's monthly payments toward the mortgage. A fixed-rate mortgage is also called a traditional mortgage.
Adjustable-Rate Mortgage (ARM)
With an adjustable-rate mortgage (ARM), the interest rate is fixed for an initial term, after which it can change periodically based on prevailing
interest rates. The initial interest rate is often a below-market rate, which can make the mortgage more affordable in the short term but possibly less affordable long-term if the rate rises substantially.
A 5/1 adjustable-rate mortgage is an ARM that maintains a fixed interest rate for the first five years, then adjusts each year after that.
Other, less common types of mortgages, such as interest-only mortgages and payment-option ARMs, can involve complex repayment schedules and
are best used by sophisticated borrowers. These types of loans may feature a large balloon payment at its end.
Many homeowners got into financial trouble with these types of mortgages during the housing bubble of the early 2000s.3
As their name suggests, reverse mortgages are a very different financial product. They are designed for homeowners age 62 or older who want to
convert part of the equity in their homes into cash.
These homeowners can borrow against the value of their home and receive the money as a lump sum, fixed monthly payment, or line of credit. The
entire loan balance becomes due when the borrower dies, moves away permanently, or sells the home.4
Within each type of mortgage, borrowers have the option to buy discount points to buy their interest rate down. Points are essentially a fee that
borrowers pay up front to have a lower interest rate over the life of their loan.
When comparing mortgage rates, make sure you are comparing rates with the same number
of discount points for a true apples-to-apples comparison.
Linda Gonzalez-Durston a Mortgage Loan Expert in CA Lic 1898004