What is a Mortgage? Understanding Mortgage Loans and How they Work

what is a mortgage

Unless you plan on buying a home using cash you’ll need to get a mortgage.

If you’re a first time home buyer you may not be entirely sure what a mortgage is.

In this article we’re going to take a deeper looking into mortgage loans to help you better understand what they are and how they work.

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What is a Mortgage?

A mortgage is a loan that is given to a borrower by a lender to purchase a home. A mortgage is often paid back over a long period of time, usually 30 years.

There are several types of mortgage loans available, you should speak to a loan officer to go over your available options.

The Down Payment

In order to get a mortgage loan you will be required to have a down payment, unless getting a VA or USDA loan which are the only two types of loans that do not require a down payment.

The down payment is a $200,000 home and your mortgage requires a 5% down payment. You will need $10,000 to put down on the loan.

Closing Costs

Closing costs are fees charged by a lender for issuing and processing a mortgage loan. Closing costs are expressed as a percentage of the purchase price with the average being between 2%-5%. Shop around so you can get the best deal on closing costs.


You will pay interest on the amount of money you borrow. Interest is charged annually, the amount will depend on several factors including the prime rate, your credit score, and the type of loan you use. Expect to pay an interest rate between 3%-6%.

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Types of Mortgage Loans

Fixed-Rate Mortgage

A fixed-rate mortgage is a loan that has an interest rate that is fixed for the life of the loan. The advantage ion a fixed-rate mortgage is that you can lock in a low rate and never have to worry about your rate or payment increasing.

Adjustable-Rate Mortgage

An adjustable-rate mortgage, also called an ARM. Is a loan that has an initial low interest rate for a fixed period of time. After the initial period is up the rate adjusts. The most common type of ARM is a 5/1 ARM which has a low rate for the first 5 years then it adjusts yearly after that.

An advantage of an adjustable rate loan is that the interest rate is usually much lower than with a fixed rate.

FHA Loans

It used to be that in order to get approved for a mortgage you needed great credit and a 20% down payment. The Federal Housing Administration was created to help encourage homeownership by making it easier to get approved for a mortgage.

FHA loans are very popular among first time home buyers because of their low credit and down payment requirements. If you have at least a 580 credit score you may qualify for an FHA mortgage with just a 3.5% down payment.

VA Loans

If you’re a Veteran you may be eligible for a VA loan. With no mortgage insurance or down payment they are the cheapest type of home loan you can get.

Conventional Loans

A conventional mortgage is a loan that is not backed by the Government. They are more difficult to qualify for usually requiring at least a 620 credit score and 10% down.

Mortgage Payment Breakdown

Principle – Mortgage principle is the balance of the loan. The principle balance is the amount you will owe if you wish to pay off your loan at any given time. Any additional payments you make are often applied to the principle.

Interest – Interest is the amount of money you pay annually, it is how the lender makes money on the loan. In the beginning of a mortgage the majority of your monthly payment goes towards the interest.

Escrow Account – Most lenders will include escrow into your monthly payment. The escrow account is for the property taxes and homeowners insurance premiums.

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Where to Get a Mortgage

Banks and Credit Unions

These days people have many choices when it comes to finding a mortgage lender. You can always walk into your local bank or credit union to get a loan.

Mortgage Brokers

Mortgage brokers act as a middle man between you and the lender. They often have several different lenders they work with and can send your application to multiple lenders easily.

Online Lenders

There are hundreds of lenders you can find online that offer mortgage loans. The entire process is completed online and by phone

Mortgage Terms

Debt-to-Income Ratio – The DTI ratio is your monthly income divided by your monthly debt obligations such as credit card and auto loan payments.

Loan-to-Value Ratio – The LTV ratio is the loan balance compared to the fair market value of a home.

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