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What Is a Mortgage? Everything You Need To Know

This type of secured loan lets you buy a home by paying a portion of the cost yourself and using the home as collateral to finance the rest.

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By Mary Beth Eastman

Written by

Mary Beth Eastman

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Mary Beth Eastman is a Credible authority on personal finance. Her work has been featured by The Balance, Money Under 30, and more.

Edited by Reina Marszalek

Written by

Reina Marszalek

Senior editor

Reina is a senior mortgage editor at Credible and Fox Money.

Updated October 31, 2023

Editorial disclosure: Our goal is to give you the tools and confidence you need to improve your finances.

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A mortgage is a loan you use to borrow funds to buy a home when you can’t (or don’t want to) pay for it all in cash. For most people, it’s a crucial part of the homebuying process.

When you use a mortgage to buy a home, you agree to use the house as collateral. That means if you stop making payments, the mortgage lender can reclaim your house. Make the payments as agreed, and the home will be yours, free and clear.

Understanding mortgages

On the surface, buying a home seems simple: You find one for sale, and pay the seller an agreed-upon price. But with the median price of a new home topping $430,000, coming up with that kind of cash isn’t easy.

That’s where a mortgage comes in. You find a home for sale, and pay the seller — but instead of using all your own cash, you borrow from a mortgage lender. The lender pays the seller for the purchase of the property, and you repay the lender, with interest.

Mortgage terms you need to know

Before shopping for a mortgage, it helps to understand some of the terms you’ll commonly find:

  • Amortization: The gradual repayment of a debt in regular installments over time.
  • APR: Annual percentage rate, or the actual yearly costs for the loan, including interest and fees.
  • Closing: The final settlement of all necessary details of a home loan.
  • Down payment: The portion of the home purchase you pay upfront, out of pocket.
  • Equity: Your ownership stake in the home.
  • Escrow: A special account that holds funds before they are transferred from one party to another.
  • Interest rate: The percentage of the loan amount you pay in interest to the lender.
  • PMI: Private mortgage insurance, which is often required for loans with less than a 20% down payment.
  • Principal: The amount borrowed, not including interest or fees.

How does a mortgage work?

It can take several weeks or months to get a mortgage. The process involves several steps, because the best mortgage lenders require a lot of documentation and verification before approval.

Usually, you’ll start with a pre-approval, during which the lender tells you how much you can likely borrow and the interest rate you can expect to pay based on the information you provide. You can use this pre-approval to begin home shopping.

Once you’ve found a home to purchase and made an offer the seller has accepted, you can apply for a mortgage. After reviewing your application, the lender may give you a conditional approval, meaning you’ll need to meet a few more conditions before the loan is formally approved. To secure the loan, you’ll put up the property as collateral, meaning you must turn it over to the lender if you fail to repay.

The specifics of your mortgage will depend on how much you put down — the down payment — as well as your interest rate. The more you put down on the home yourself, the less you need to borrow. And the lower the interest rate, the less interest you’ll need to pay on top of the cost of the home. That’s why it always pays to shop around when you’re ready to get a mortgage.

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Types of mortgages

There are many different types of mortgages, each with different features and terms. The most common types include:

  • Conventional mortgage: Any mortgage that is not part of a government program.
  • Fixed-rate mortgage: A home loan with an interest rate that does not change over time.
  • Adjustable-rate mortgage: A mortgage with an interest rate that changes based on market conditions.
  • Government loans: These mortgages are insured by the federal government, allowing lenders to extend financing to buyers with lower credit scores or down payments.
  • Jumbo loans: Mortgages that are larger than conventional loan limits approved by the Federal Housing Finance Agency.

Pros and cons of mortgages

Mortgage type
Pros
Cons
Conventional
Low down payments and flexible terms available
Stricter qualifying criteria; may require private mortgage insurance
Fixed-rate
Predictable payments
Rates don’t drop when market changes
Adjustable-rate
Low interest rates during introductory period
Rates may rise when market changes
Government-backed
Low down payments; low credit score requirements
Potentially higher APRs; loan caps; may require mortgage insurance premiums
Jumbo
Larger loan amounts; greater flexibility
Tougher qualification criteria; may require cash reserve

How to get a mortgage

These are the basic steps to get a mortgage:

  • Determine your budget: Start by evaluating your expenses to see how much you can afford to put toward a mortgage each month.
  • Review your credit report: Look for any errors that could be affecting your credit score.
  • Get pre-approved: When you apply for a pre-approval, the lender will review your credit history, income, debts, and other factors to determine how much you could borrow.
  • Compare lenders: Rather than going with the first lender you find, compare different loan options before you choose a mortgage. The lower your interest rate, the less you’ll pay in the long run.
  • Make the deal: A real estate agent can help you find a home, make an offer, and negotiate with the seller on the terms of the sale.
  • Get approved: Once you’ve chosen a house and a lender, complete the mortgage application and wait for approval.
  • Close on the sale: The last step is to close on the property. Closing is where you’ll complete the final paperwork and transfer the title into your name.

Getting a mortgage is not a one-size-fits-all process. “There are so many nuances to how a bank will review a loan file,” said Sarah Alvarez, vice president at William Raveis Mortgage. “You want to make sure that you are putting your best foot forward when making an application.” Alvarez recommends speaking to a professional who can help you during this process.

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Calculate the cost of a mortgage

Different factors will change the cost of your mortgage, including the type of mortgage, your interest rate, and how much you put down as a down payment.

For example, suppose you apply for a $250,000 mortgage. With 5% interest and a 30-year fixed term, your payments would be $1,342 monthly and you’d wind up paying $483,139 by the end of the loan.

If your interest rate was 8% instead, your monthly payment would be $1,834 and you’d pay $660,388 in total by the end of the loan.

You can use Credible’s mortgage calculator to see how different factors affect your mortgage costs over time.

FAQ

Why do I need a mortgage?

With the median price of a home hovering near $400,000 in 2023, not many people can afford to buy one outright with cash. Getting a mortgage lets buyers pay a small percentage of the price upfront and finance the rest over time.

What credit score do I need to qualify for a mortgage?

With credit scores, higher is better when it comes to qualifying for a mortgage.

“The very best rates are reserved for 780+ (although some banks use 740+),” Alvarez said.

That’s why checking your credit history and credit score ahead of time is important; it can help you target the right loan options for your situation, and can also provide you with motivation to boost your credit score if necessary.

What is the minimum down payment required for a mortgage?

If you can save up at least 20% for a down payment, you’ll avoid having to pay private mortgage insurance (PMI).

But many conventional and government-backed loans are available that will allow you to put down much less. For example, you could qualify for a loan from the Federal Housing Authority (FHA) with just 3.5% down, and some lenders will approve conventional loans with as low as 3% down.

What are the three types of mortgages?

The three main types of mortgages are fixed-rate, conventional, and standard adjustable-rate mortgages. In addition to these, you’ll also often encounter government-backed loans (such as FHA, VA, or USDA loans) and jumbo loans.

How can I lower my mortgage interest rate?

You may be able to lower your rate by making a larger down payment, improving your credit score, or buying down your rate with points. Adjustable-rate mortgages are another option for lowering your rate in the short term.

“In an elevated rate market, it doesn’t necessarily make sense to lock in for the long term, and banks incentivize you to take an adjustable rate by offering lower rates for lower fixed periods,” said Alvarez.

The best way to ensure you get a low rate is to shop around and compare lenders to find the best terms for your situation.

Meet the expert:
Mary Beth Eastman

Mary Beth Eastman is a Credible authority on personal finance. Her work has been featured by The Balance, Money Under 30, and more.