What Is a Mortgage?
A mortgage is a type of loan used to finance the purchase of a home. Mortgages are typically paid off in installments over a set time period, with part of each payment going toward principal and the rest towards interest. The interest rate varies, with riskier borrowers paying higher rates. Mortgages can be obtained through banks, credit unions, specialized mortgage lenders, online-only mortgage lenders or unaffiliated mortgage brokers.
A mortgage functions much like a car loan or any other installment debt you might take out, but it is more complicated because it involves real estate as collateral. If you fail to repay your mortgage within the set term, or “mortgage duration,” then the lender can repossess and sell your property in order to recoup its losses. Despite the risk of foreclosure, mortgages are considered good debt because you’re borrowing against an asset that typically appreciates in value over time.
To qualify for a mortgage, potential borrowers must undergo a thorough application process that includes supplying financial documentation and passing a credit check. If approved, you’ll sign an agreement that outlines the terms of your loan. In most cases, you’ll be required to put a down payment on the property as well.
The most common mortgage is a conventional loan, which can be backed by Fannie Mae or Freddie Mac. These loans must meet certain criteria including maximum loan amounts, minimum borrower down payments and a debt-to-income ratio. Conventional mortgages can also be insured by private mortgage insurance companies. Generally, when you’re purchasing a home with a conventional mortgage, your monthly mortgage payment will include a fee for this private mortgage insurance.
Another kind of mortgage is an adjustable rate mortgage (ARM), which offers the option to change the interest rate and monthly payment at certain intervals during the loan term. You’ll also likely pay a fee for these adjustments, which are known as “points.”
A mortgage is usually paid off in a series of installment payments that span 15-30 years. Each monthly payment will chip away at the principal, reducing your overall mortgage balance and building equity in your property.
Aside from being an important investment, a mortgage is also an expensive commitment. It’s best not to make a mortgage unless you can comfortably afford the repayment obligation for the entire term of your loan. You should always compare the loan terms and conditions of multiple lenders before choosing a mortgage. This will ensure that you’re getting the best deal. You may also wish to consider using a mortgage broker, who has access to many lenders and can save you time in the application process. However, you should always ask a mortgage broker how they’re paid, as this can impact the loan terms they offer. Some brokers charge a flat fee at closing or as an add-on to your interest rate, while others are compensated by the lenders they represent. This can make the difference between getting a great mortgage or a bad one.