What Is a Mortgage?
A mortgage is a loan from a financial institution to help you purchase a home or plot of land by using the property as collateral. Borrowers typically make payments on a monthly basis that are divided into principal and interest. The cost of the loan may include other fees, including mortgage insurance and an origination fee (points). Mortgages are available from a variety of sources, such as banks, credit unions and specialized lenders that offer home loans. Mortgages are subject to a rigorous application and underwriting process that ensures borrowers can afford the loan. They also must meet lender and loan requirements, such as a minimum credit score and down payment.
A lender’s interest rate is based on macroeconomic factors, such as the federal funds rate and the economic environment, and the borrower’s financial fitness, including his or her credit history, assets and debt. The higher a borrower’s credit score and more desirable his or her assets, the lower the mortgage rate is likely to be. Borrowers can sometimes get a lower mortgage rate by paying points up front.
Mortgages are unlike some other types of loans, like personal loans, because they are secured by an asset that can be taken away if the borrower fails to repay the loan. The lender can sell a borrower’s house to recoup the amount of the outstanding loan balance, which is why mortgage lenders usually only lend money to people who can afford to make repayments on time.
Many mortgage loan applications require a down payment of at least 20% of the home’s purchase price. However, it is not uncommon for borrowers to pay a much smaller down payment than this amount. The amount of the down payment affects the total cost of the loan, because it reduces the amount of money a borrower must pay each month in order to reach the final maturity date of the mortgage.
In addition to the loan principal, most mortgages require borrowers to pay property taxes and homeowners insurance each year. Lenders typically collect these amounts as part of a borrower’s monthly mortgage payment, place them in an escrow account and pay the annual premiums to the relevant authorities when they are due.
Some home loan programs allow borrowers to make payments that are less than the full amount of interest owed each month, which causes the principal balance to increase over the life of the loan. Others require a lump-sum “balloon” payment at the end of the loan term. Mortgages that are not fully amortized are often referred to as negative-amortization mortgages.