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- A mortgage is a type of loan for buying a home.
- You'll choose from a conventional or government-backed mortgage, with either a fixed or adjustable rate.
- To get a mortgage, you'll typically need a decent credit score, a low DTI, and at least a 3% down payment.
With median home prices now well above $400,000, most people can't afford to buy a home all in cash. In 2022, 78% of homebuyers used a loan to purchase their home, according to the National Association of Realtors.
But you can't just use any type of loan. To buy a house, you'll need to get a mortgage.
What is a mortgage?
A mortgage is a type of loan used to purchase a home. When you get a mortgage, you agree that the lender can foreclose on your property if you fail to repay the loan.
This is because a mortgage is a type of secured loan. A secured loan requires you to put an asset up as collateral in case you fail to make payments.
In this case, the collateral is your house. If you don't make mortgage payments for an extended period of time, then the bank or mortgage lender that owns your mortgage can start foreclosure proceedings, which means it can take the home from you and sell it at a foreclosure auction.
This is different from an unsecured loan, such as a student loan. Unsecured loans aren't backed by any collateral, which means if you stop paying, the lender can't take property from you. It can, however, sue you for what you owe, send you to collections, or potentially garnish your wages
How does a mortgage work?
To get a mortgage, you'll apply with a bank or mortgage lender. To qualify, you'll need a decent credit score, a low debt-to-income ratio, and a sufficient down payment. If you have a good credit score, you may be able to get a better interest rate, which can save you money in the long run.
Unless you qualify for a mortgage that allows 100% financing, you can't get a mortgage for the full purchase price of the home you're buying. This is where your down payment comes in. You'll pay at least 3% of the home's price, and the mortgage will cover the rest.
There are a variety of different types of mortgages you can get, with different term lengths and rate types. Some mortgages are paid back over just eight, 10, or 15 years, but most are set up to be paid back over the course of 30 years.
There are consequences if you don't make mortgage payments on time. You'll pay late fees, and the lender will send you a notice of delinquency. If you continue to miss payments, the lender will start the foreclosure process, and you can lose your home.
Types of mortgages
There are several types of mortgages, but most can be broken down into two categories: conventional and government-backed mortgages.
Conventional mortgage
Conventional mortgages are offered by private lenders and are often backed by the government-sponsored enterprises Fannie Mae or Freddie Mac. These types of loans are not secured by a government agency.
Conventional mortgages typically require a good credit score and 3% to 10% for a down payment.
There are two basic types of conventional loans: conforming and nonconforming.
- Conforming loan: The loan meets Fannie Mae and Freddie Mac's standards, and the loan amount is within the annual limits set by the Federal Housing Finance Agency (FHFA). In 2023, the limit is $726,200 in most parts of the US. In areas with a higher cost of living, the limit goes up to a ceiling of $1,089,300.
- Nonconforming loan: A nonconforming loan doesn't meet the standards for a conforming loan. The most common type of nonconforming loan is a jumbo loan, which is a mortgage that exceeds the borrowing limit set by the FHFA. You'll need a higher credit score, bigger down payment, and lower debt-to-income ratio to qualify. You'll also pay a higher interest rate.
Government-backed mortgage
Government-backed mortgages are offered by private lenders and are secured by a federal government agency. They typically have looser requirements surrounding credit scores, down payments, and/or debt-to-income ratios.
There are three common types of government-backed loans:
- Veterans Affairs (VA) loan: You might be eligible if you're affiliated with the military. "The VA loan is great for veterans, because it is 100% financing," says Christian Ross, managing broker for Engel & Völkers Atlanta. "There is a funding fee that goes along with that, but that can be financed in so that you are paying that fee wrapped into your mortgage. So you can put nothing down and just pay your closing costs."
- United States Department of Agriculture (USDA) loan: You may qualify if you're buying a home in a rural or suburban part of the country.
- Federal Housing Administration (FHA) loan: An FHA loan isn't for a specific group of people, like VA and USDA loans are. But it comes with some restrictions, such as minimum property standards, that could prevent you from buying a home that isn't in great condition.
Once you've decided between a conventional and government-backed loan, you have another decision to make. Do you want a fixed-rate mortgage or an adjustable-rate mortgage?
Fixed-rate mortgage
A fixed-rate mortgage locks in your rate for the entire life of your loan. Although US mortgage rates fluctuate, you'll still pay the same interest rate throughout your entire mortgage. They can be especially good options if you plan to live in the home for a long time. Keeping the same rate for years gives you stability.
If you get a fixed-rate mortgage, you'll need decide on your term length. Individual lenders may have multiple term length options, but these are the two most common:
- 30-year fixed-rate mortgage: A 30-year mortgage is the most common term length. You'll spread payments out over 30 years and pay the same rate the entire time.
- 15-year fixed-rate mortgage: You'll pay less interest on a 15-year mortgage than a 30-year mortgage because lenders charge a lower rate, and the term is shorter. As a result, you'll pay interest for a shorter chunk of time. But monthly payments will be higher than on a longer term, because you're paying off the same amount of money in half the time.
Adjustable-rate mortgage
An adjustable-rate mortgage, or ARM, keeps your rate the same for the first few years, then regularly changes over time — typically once a year.
With an ARM, your rate stays the same for a certain number of years, called the "initial rate period." Then it changes periodically. The initial rate is usually lower than what you would get with a fixed-rate mortgage.
Some of the most common term length options are 3/1 ARMs, 5/1 ARMs, or 10/1 ARMs. The numbers tell you how long your introductory period is, and how often the rate will adjust. With a 5/1 ARM, for example, your introductory rate period is five years, and then your rate will go up or down once a year for 25 years.
"When it comes to fixed-rate versus adjustable-rate mortgages, it really depends on your goals," says Ross.
If you can get a lower rate now with an ARM and expect to move before the initial rate period ends, it could be a good deal.
However, Ross emphasizes the importance of understanding the terms of your ARM so that you know when your rate will change and how to prepare. Your rate could increase at the end of your initial rate period, depending on your finances and the economy.
Other types of mortgages
If you find yourself in a unique situation, one of the following mortgage types could be the best fit:
- Construction loan: You need money for building your own home, or for making significant renovations to the home you're buying.
- Balloon mortgage: Make small monthly payments for a set number of years, then pay off the remaining principal in one lump sum. You might like a balloon mortgage if you want low monthly payments and are confident you'll have the money for a balloon payment once the loan term is up.
- Interest-only mortgage: Only pay the interest charged on your mortgage for the first few years, then start making regular mortgage payments. As with a balloon mortgage, an interest-only mortgage could be a good option if you want low monthly payments and believe you'll be able to afford higher payments down the road.
- Reverse mortgage: If you're age 62 or older, you can receive the equity you've built in your home as cash — in a lump sum, in monthly installments, or as a line of credit.
- Non-QM loan: Non-qualified mortgages, or non-QM loans, are a type of mortgage available to borrowers with unusual situations that prevent them from qualifying for other mortgage types. These loans are often marketed to self-employed borrowers, those who have recent bankruptcies or foreclosures, or others who might have trouble qualifying for a traditional mortgage. They often have high interest rates to account for the risk of the loan.
How to choose the best type of mortgage
Choosing the best type of mortgage for your needs can be tricky. Break it down into a few steps:
- Conventional or government-backed? If your credit score, debt-to-income ratio, or down payment aren't strong enough to qualify for a conventional mortgage, a government mortgage could be a good fit. Once you decide between the two, you'll choose either a conforming or nonconforming loan (conventional) or a VA, USDA, or FHA loan (government-backed).
- Fixed-rate or adjustable-rate? A fixed-rate mortgage provides stability. An adjustable rate usually starts lower than a fixed rate, but it could go up later.
- Which term length? Think about your goals for paying down your mortgage. If you want lower monthly payments, you might like a longer term, such as 30 years. But if you're willing to make higher payments to pay off your mortgage sooner, you may want a shorter term.
- Any special considerations? If you find yourself in a unique position, such as building your own home, you may go with a nontraditional type of mortgage.
"The best thing is really to talk to your lender and examine all the options," says Ross.
What goes into a mortgage payment
You'll make monthly payments on your mortgage, and various expenses make up a monthly payment. This is often abbreviated as "PITI," or principal, interest, taxes, and insurance.
Principal
The principal is the amount the lender gives you upfront. If you borrow $200,000 from the bank, then the principal is $200,000. You'll pay a little piece of this back each month.
Interest
When the lender approved your mortgage, you agreed on an interest rate — the cost of your loan. The interest is built into your monthly payment.
Property taxes
The amount you pay in property taxes depends on two things: the assessed value of your home and your mill levy, which varies depending on where you live. Your property taxes can add hundreds or even thousands to your mortgage payments annually.
Homeowners insurance
Homeowners insurance covers you financially should something unexpected happen to your home, such as a robbery or tornado.
The average annual cost of homeowners insurance was $1,311 in 2020, according to the most recent release of the Homeowners Insurance Report by the National Association of Insurance Commissioners (NAIC).
Mortgage insurance
Private mortgage insurance (PMI) is a type of insurance that protects your lender should you stop making payments. Lenders require PMI if your down payment is less than 20% of the home value.
PMI can cost between 0.2% and 2% of your loan principal per year. If your mortgage is $200,000, you could pay an additional fee between $400 and $4,000 per year until you've paid off 20% of your home value and no longer have to make PMI payments.
Keep in mind that PMI is only for conventional mortgages. Most other mortgages have their own types of mortgage insurance with different sets of rules.
Mortgage terminology you'll need to know
When buying a home, you'll encounter a lot of jargon. Here are some of the most common mortgage-related words you'll hear and what they mean:
How to get a mortgage
If you've decided you want to apply for a mortgage, you can follow these steps.
Get your finances in order
Having a strong financial profile will increase your chances of being approved for a loan, and help you score a lower interest rate. Here are some steps you can take to beef up your finances:
- Figure out how much home you can afford. The general rule of thumb is that your monthly home expenses should be 28% or less of your gross monthly income.
- Find out what credit score you need. Each type of mortgage requires a different credit score. Requirements can vary by lender, but you'll probably need a score of at least 620 for a conventional mortgage. You can increase your score by making payments on time, paying down debt, and letting your credit age.
- Save for a down payment. Depending on which type of mortgage you get, you may need as much as 20% for a down payment. Putting down even more could land you a better interest rate.
- Check your debt-to-income ratio. Your DTI ratio is the amount you pay toward debts each month, divided by your gross monthly income. Many lenders want to see a DTI ratio of 36% or less, but it depends on which type of mortgage you get. To lower your ratio, pay down debt or consider ways to increase your income.
Shop around
You shouldn't necessarily just apply with your personal bank. Find a lender that provides the type of mortgage you need. Then shop around for a lender that will offer you the lowest rates, charge you the least in fees, and make you feel comfortable.
Ross recommends getting referrals from friends or your real estate agent to narrow down your options. And just because your realtor recommends a lender doesn't necessarily mean there's a conflict of interest.
"A lot of times, there's a good working relationship," she says. "Just make sure that you receive at least three recommendations."
If you're early in the homebuying process, apply for prequalification or preapproval with several lenders to compare and contrast what they're offering.
Choose the home and apply for approval
Once you've chosen the lender you want to work with, choose the home you want to buy. After you get an offer accepted and are under contract, apply for full mortgage approval.
The lender will check back in with your finances, then set up an appraisal for the home to make sure the sales price matches the home's market value. If everything passes the test, then it will approve you for a mortgage.
Close on your mortgage
On closing day, you'll wire the funds you need to close on your mortgage to the entity handling the closing, often a title company. You may also be able to pay with a cashier's check. The funds will include your down payment as well as any closing costs you owe.
During closing, you'll sign documents finalizing the loan. After you're done signing, you'll be legally responsible for paying back the mortgage. You'll typically close on your home purchase at this time as well.
What is a mortgage frequently asked questions
Is a house loan a mortgage?
Yes, in the simplest terms, a mortgage is just a loan you use specifically to buy a house. When someone says they're getting a home loan, that's a mortgage.
How long does it take to pay off a mortgage?
Most borrowers get 30-year mortgages since longer terms have lower monthly payments. However, people generally don't hold onto their mortgages for the full 30 years and end up paying it off when they refinance or sell their home.
Who owns the house in a mortgage?
When you have a mortgage, do you really own your home? Yes. Your lender will place a lien on your house, meaning it has the right to foreclose if you stop making payments. But your name will be on the deed, and you'll be the legal title holder on the property.
How often do you pay a mortgage?
Typically, you'll make monthly payments on your mortgage. However, your lender may offer the option for you to set up biweekly payments, which will actually help you pay off your loan a little faster.