What is a mortgage?
A mortgage is a loan that's used to buy real estate — typically residential property. According to the Consumer Financial Protection Bureau, it's an “agreement between you and a lender that gives the lender the right to take your property if you fail to repay the money you've borrowed plus interest.” In other words, it's the legal document you have to sign to finance a house.
Of all the different types of mortgage loans, conventional and government-backed mortgages are most frequently used to finance a home.
How does a mortgage work?
A mortgage functions as a lien or legal claim against a property (a single-family house, condo, duplex, etc). In exchange for immediate funds, the borrower must repay the loan with interest and fees over time.
Conventional mortgages require a minimum 620 credit score.
The term refers to the life span of the loan, which is usually between 15 and 30 years. There are also 10-year term options. The mortgage rate refers to the amount of interest the lender charges in exchange for the loan.
Mortgage rates can be fixed or adjustable. A fixed-rate mortgage has the same interest rate for the entire loan term, whereas an adjustable-rate mortgage increases or decreases based on a changing index.
“Mortgage amortization” is the process of paying down home loan debt over time. Homeowners build equity by making payments on their mortgage principal. If you get a second mortgage, you borrow funds with your house as collateral for the loan but don't have to use the funds to purchase a home. Home equity loans and lines of credit are types of second mortgages.
Learn more: Read about what a mortgage is and how it works.
How does refinancing work?
Mortgage refinancing companies replace your existing mortgage with a new loan. The two most common types of home refinance loans are rate-and-term refinancing and cash-out refinancing.
Many homeowners refinance their mortgage to lower their monthly payments, get a better rate, convert home equity into cash or pay off their loan faster. Some mortgage refinance lenders also specialize in debt consolidation strategies.
For example, the home equity conversion mortgage (HECM) is a reverse mortgage backed by the federal government. This program lets you draw on your home's equity to borrow money.
Learn more: Read about how to refinance a mortgage or compare top refinancing lenders.
Mortgage broker vs. lender
Loan officers work for financial institutions and handle the lending process. On the other hand, brokers negotiate with lenders on your behalf to find a loan program with the best terms for you.
- Mortgage broker: A mortgage broker is the middleman between a borrower and a mortgage lender. Working with a broker can save time and money, especially if you want to compare multiple lenders.
A broker can also help manage your paperwork and fees during the homebuying process. However, brokers typically aren't able to guarantee cost estimates and may not have access to all the lenders in your area. - Mortgage lender: A mortgage lender is the banking institution that finances the home loan for a fee. Mortgage lender origination and closing fees vary by lender and from state to state. Mortgage banks and portfolio lenders are types of direct mortgage lenders.
Direct lenders process applications and originate and underwrite loans. A lender is different from a mortgage servicer, which processes loan payments, responds to borrower inquiries and manages escrow accounts.
How much is a mortgage?
The average mortgage is $840 to $1,200 per month. Most financial experts suggest keeping your mortgage payment below 30% of your monthly gross income (and your total debt-to-income ratio lower than 36%). Use our mortgage calculator to determine how much house you can afford.
Keep in mind that the total cost of a mortgage is more than just the price of your house. As you compare mortgage companies, consider closing costs, mortgage points and prepayment penalties.
- Down payment: A down payment is the part of the total sale price that you put down upfront. The amount required depends on the loan type. FHA loans, for example, require at least 3.5%, while VA or USDA loans don't require down payments. Some government agencies and nonprofits offer down payment assistance programs.
- Closing costs: Closing costs amount to 2% to 5% of the home loan and include application fees, lender fees, attorney fees, earnest money, escrow fees, courier fees, homeowners association transfer fees, inspection fees and title insurance.
- Origination fees: Lenders charge loan origination fees for services like mortgage application and underwriting. Origination fees are usually a small percentage (between 0.5% and 2%) of the total loan amount, though some mortgage lenders offer fixed fees of $1,000 or less.
- Mortgage points: Sometimes called discount points, mortgage points are optional fees paid to your lender in exchange for a lower interest rate. Each point is equal to 1% of the mortgage loan amount.
- Prepayment penalties: A prepayment penalty is a fee that some lenders charge when a borrower pays their mortgage loan off early, either through refinancing or overpaying each month. The average prepayment fee is 80% of six months of interest.
What makes up a monthly mortgage payment?
Once you've covered all the upfront costs of a home loan, your monthly mortgage payments include principal, interest, taxes and insurance (PITI). In some cases, other regular expenses include homeowners association or condo fees.
- Principal: The principal is the balance of the loan amount you borrowed. Each month, your mortgage payment reduces the principal.
- Interest: Interest is the amount you agree to pay your lender in exchange for a mortgage loan. Fixed interest rates stay the same throughout the term of the loan. Adjustable interest rates can vary over the life of the loan.
- Property taxes: Property taxes are often included in mortgage bills. Lenders keep your property tax payments in an escrow account until they're due and then pay them on your behalf.
- Mortgage insurance: Mortgage insurance protects the lender if you stop making payments on your loan. The two types of mortgage insurance are private mortgage insurance (PMI) and mortgage insurance premiums (MIP). For conventional mortgages, you can avoid the need to pay for PMI by making a down payment of 20% or more. For FHA and other government-backed loans, you can avoid MIP after 11 years by putting at least 10% down.
- Homeowners insurance: Homeowners insurance covers damage from fire, storms, theft and other perils. Most lenders require homeowners insurance and charge premiums on your mortgage bills.
How to apply for a mortgage
These days, you can complete almost the whole mortgage process online. After you've checked your credit score, figured out how much house you can afford and researched the best mortgage lenders, it's time for some paperwork.
Keep in mind that the mortgage lender makes a hard inquiry on your credit when you apply. Hard inquiries cause your credit score to take a small dip, so only try to get preapproved when you're serious about putting in an offer on a home.
