If you’re considering homeownership and unsure where to begin, you’ve come to the right place. We’re breaking down all the mortgage essentials, from loan types and key mortgage terms to the home buying process and more.

What Is a Mortgage and How Does It Work?

Let’s begin by defining what a mortgage is. A mortgage is a loan provided by a lender that allows borrowers to purchase or refinance a home. In return, the borrower agrees to repay the lender through monthly mortgage payments, which typically cover the loan principal, interest, and any additional fees.

Mortgages are considered secured loans because they are backed by collateral— in this case, the home itself. If the borrower falls behind on payments or fails to meet the terms of the mortgage, the lender has the legal right to take possession of the home through foreclosure.

When you take out a mortgage, your lender provides a specific amount of money to help you purchase a home. In exchange, you commit to repaying the loan with interest over a set period of time. The lender maintains a claim on the property until the mortgage is entirely paid off. Fully amortized loans follow a structured repayment plan, ensuring the entire loan is paid off by the end of the term.

One key difference between mortgages and other types of loans is that if you’re unable to repay your mortgage, the lender can sell your home to recover its losses. This is not the case with unsecured loans, such as personal loans. Since personal loans are not tied to collateral, you won’t risk losing your home or other assets if you fall behind on payments.

Who’s Involved in the Process?

Several parties may be involved in a mortgage transaction: the mortgage lender, the borrower, and possibly a co-signer.

Borrower

The borrower is the individual seeking a loan to purchase a home. You can apply as a sole borrower or with a co-borrower. Adding co-borrowers to the mortgage can increase the total amount you’re eligible to borrow, as combining incomes typically boosts your qualification for a higher-priced home.

Lender

A mortgage lender is a financial institution that provides the funds needed to purchase a home. This lender could be a bank, credit union, or an online company. When you apply for a mortgage, the lender reviews your financial details and credit history—including your credit score, income, assets, and debts—to ensure you can afford the loan payments and meet both lender and loan requirements.

Co-Signer

A lender might require a borrower to get a co-signer for a mortgage if the borrower has a weak credit history or no credit history at all. Although the co-signer does not have ownership rights to the property, they agree to take on the financial responsibility of repaying the mortgage if the primary borrower defaults on the loan.

Understanding Mortgage Payments

Your monthly mortgage payment, the amount you pay each month, consists of four main components: principal, interest, taxes, and insurance (PITI).

Principal Amount

Principal refers to the total amount you borrowed from the lender. Each monthly mortgage payment includes a portion that reduces this principal balance. If you aim to pay off your loan sooner, making extra payments toward the principal can help you pay down the balance more quickly. This approach reduces the total amount you owe and decreases the interest you’ll pay over the life of the loan.

Interest

Interest is the cost of borrowing from a lender and is calculated based on your interest rate and loan principal. Each month, you pay interest directly to your mortgage lender. As your loan progresses and the principal balance decreases, the amount of interest you pay each month will also reduce.

Insurance and Taxes

If your loan includes an escrow account, it will collect funds for your property taxes and homeowners insurance as part of your monthly mortgage payment. Your lender will hold this money in the escrow account and use it to pay your taxes and insurance premiums when they are due.

Mortgage Insurance

Most borrowers are required to pay mortgage insurance if their down payment is less than 20%. For conventional loans, this is known as private mortgage insurance (PMI). Federal Housing Administration (FHA) loans require a one-time upfront mortgage insurance premium (UFMIP) as well as ongoing monthly MIP payments, regardless of the down payment amount. Department of Veterans Affairs (VA) loans involve a funding fee, which can be included in the mortgage. U.S. Department of Agriculture (USDA) loans require both an upfront and a monthly guarantee fee.

• PMI: Private mortgage insurance (PMI) safeguards lenders in case a borrower defaults on a conventional loan. Borrowers generally pay PMI if their down payment is less than 20%. Once borrowers reach the 20% equity threshold in their home through mortgage payments and achieve a loan-to-value (LTV) ratio of 80%, they can usually request to have PMI removed.

PMI typically costs between 0.2% and 2% of your total loan amount. The premium can be paid as part of your monthly mortgage payment, as a one-time upfront payment at closing, or through a combination of both methods. Alternatively, with lender-paid PMI, the lender covers the cost of PMI in exchange for a higher interest rate on the mortgage.

• MIP: With an FHA loan, you must pay an upfront mortgage insurance premium (MIP) regardless of your down payment amount. If you make a down payment of at least 10%, you’ll pay monthly MIP for the first 11 years of the loan. If your down payment is less than 10%, you’ll continue to pay monthly MIP for the entire duration of the loan.

Steps to Getting a Mortgage

If you’re a salaried employee with a strong credit score and your income meets a lender’s criteria, securing a mortgage should be a smooth process. Here’s a summary of the steps to follow to obtain a mortgage and become a homeowner:

1. Obtain Preapproval

Although getting preapproved is optional, having a preapproval is crucial to gaining credibility with real estate agents and sellers in today’s market. Securing initial approval from a mortgage lender before you start house hunting is highly recommended. A preapproval provides an estimate of how much you can borrow, helping you avoid looking at homes that exceed your budget. In competitive markets, some real estate agents may not even meet with you until you have a preapproval letter in hand.

You can use an affordability calculator to get a rough idea of what you might be able to afford when you start considering buying a home. However, this figure is only an estimate and not verified. A mortgage preapproval, on the other hand, involves a lender reviewing your financial information and issuing a preapproval letter. This letter indicates to sellers and agents that you’re conditionally approved for a mortgage, pending the appraisal of the home.

2. Shop for a Home and Make an Offer

Get in touch with a real estate agent to begin touring homes. They can arrange viewings and find open houses for you to visit. In some areas, you can also browse homes online through a multiple listing service (MLS). Your agent will act as your guide in identifying the best properties, negotiating prices, and making offers.

3. Secure Final Approval

Securing an accepted offer is just the beginning. To finalize your financing and complete the sale, several additional steps are required. If you were preapproved, your lender will reverify your credit, income, employment, and assets to ensure you still qualify for the loan. If you weren’t preapproved, this is when your initial approval will take place.

While you arrange a home inspection to evaluate the property’s condition, the lender will order a home appraisal to confirm its value. Additionally, the lender will engage a title company to examine the home’s title and ensure there are no issues that could hinder the sale or cause problems in the future.

4. Close Your Loan

Once the loan is approved, you’ll finalize the process by meeting with the seller, your lender, and your real estate agent to close the loan and receive the keys to your new home. At the closing, you’ll pay your down payment and closing costs and sign the mortgage agreement.

Types of Mortgages Explained

There are various types of home loans, each with its own requirements, interest rates, and benefits. Mortgages generally fall into two main categories: conforming and non-conforming loans. Non-conforming loans include government-backed, jumbo, and non-prime mortgages.

Conventional Loans

Conventional loans are a popular option for many buyers. Depending on your financial situation, credit score, and homeownership history, you might qualify for a conventional loan with as little as a 3% down payment, allowing you to purchase a home sooner. However, if you put down less than 20%, you’ll need to consider the additional monthly cost of private mortgage insurance (PMI).

Jumbo Mortgages

Conforming mortgages have specific lending limits. In 2024, the limit for most of the U.S. is $766,550, while in high-cost areas, it can go up to $1,149,825. If you’re looking to purchase a home that exceeds these limits, you’ll need to apply for a jumbo loan to secure the necessary financing.

Jumbo mortgages exceed conforming loan limits and are not backed by government agencies, classifying them as conventional non-conforming loans. Typically, a jumbo loan requires a minimum of a 20% down payment and involves extensive paperwork for approval.

Government-Insured Loans

Many lenders offer government-backed mortgages, which are particularly appealing to first-time homebuyers, low- to moderate-income borrowers, and those with smaller savings or credit challenges. These loans often come with more flexible requirements and benefits that make homeownership more accessible.

• USDA Loan: USDA loans, backed by the U.S. Department of Agriculture, are available for homes in USDA-approved suburban and ruralareas.To qualify, a borrower’s household income must not exceed 115% of the median income for the area. USDA loans offer the advantage of a 0% down payment, and for some borrowers, the USDA’s guarantee fee may be lower than the FHA mortgage insurance premium.
• FHA Loan: FHA loans, backed by the Federal Housing Administration, are popular for their low credit score and down payment requirements. You can secure an FHA loan with a 3.5% down payment and a credit score as low as 580. The FHA guarantees to reimburse lenders if a borrower defaults on the loan, which helps mitigate the risk lenders take. This guarantee encourages lenders to offer loans to borrowers with lower credit scores and smaller down payments.
• VA Loans: VA loans, backed by the Department of Veterans Affairs, are available to qualified active-duty military members, National Guard members, reservists, veterans, and their surviving spouses. They are an excellent option for those who qualify, offering the benefits of a 0% down payment and no mortgage insurance.

How Lenders Set Interest Rates?

Several factors influence your mortgage rate, some of which are beyond both the lender’s and borrower’s control. Two main factors are current market rates and the level of risk associated with the loan. While you cannot control market rates, you can influence how a lender views your application. A higher credit score can make lenders more confident in your ability to make timely payments, potentially leading to better mortgage rates.

Your debt-to-income ratio (DTI) is another factor you can influence, similar to your credit score. A lower DTI ratio indicates that you have more income available for your mortgage payments, which can make you a more attractive borrower. If your financial indicators, such as DTI ratio and credit score, reflect overall financial health, you’re more likely to qualify for a lower interest rate.

Income, Assets, and Credit Score

While you can’t control current market rates, you can manage your finances to improve your chances of getting a favorable mortgage rate. Monitor your debt-to-income ratio and credit score closely. By minimizing red flags on your credit report, you increase your likelihood of qualifying for the lowest possible rates.

You generally need to meet several eligibility requirements for the loan. While specific criteria can vary by loan type and lender, most borrowers should have a steady income, a debt-to-income ratio below 50%, and a reasonable credit score. For FHA or VA loans, a credit score of at least 580 is usually required, while conventional loans typically require a score of at least 620.

Fixed-Rate vs. Adjustable-Rate Mortgages

Fixed Rate Mortgages

Fixed interest rates remain constant throughout the entire term of the mortgage. For example, with a 30-year fixed-rate loan at a 6% interest rate, you’ll pay 6% interest for the duration of the loan, whether you pay off the loan or refinance. Fixed-rate loans provide predictable payments, which can simplify budgeting and financial planning.

Adjustable Rate Mortgages

Adjustable-rate mortgages have interest rates that change with the market conditions. Typically, ARMs come with a 30-year term and feature an initial fixed-rate period of 5, 7, or 10 years. After this initial period, the interest rate adjusts periodically—usually every 6 months to a year—based on market rates. As a result, your monthly mortgage payment may increase or decrease depending on changes in the interest rate.

If you are planning to refinance or move before the fixed-rate period concludes or if you have a high mortgage amount, an adjustable-rate mortgage can provide lower initial interest rates compared to fixed-rate loans.

Mortgage Lingo

You might come across unfamiliar terminology while shopping for a home. Check out our glossary to familiarize yourself with common mortgage terms.

Amortization: Each monthly mortgage payment is split between interest and principal repayment. Amortization refers to how these payments are allocated over the life of the loan. At the start of your loan repayment, a larger portion of your payment will go toward interest. As time goes on, a greater share of your payment will be applied to reducing the principal balance.

Down payment: A down payment is the initial amount of money you pay when purchasing a home. Typically, you’ll need to make a down payment to secure a mortgage. The required down payment varies depending on the type of loan you choose. Generally, a larger down payment can lead to better loan terms and a lower monthly mortgage payment.

If you put a 20% down payment on a conventional loan, you’re likely to receive a favorable interest rate and avoid paying private mortgage insurance (PMI). However, if you make a 3% down payment—the minimum for conventional loans—you’ll likely be required to pay PMI, which will increase your monthly mortgage payment. Using a mortgage calculator can help you see how different down payment amounts will impact your monthly payments.

Interest Rate: An interest rate is the percentage a lender charges each month for borrowing money. This rate is influenced by macroeconomic factors, such as the federal funds rate, as well as a borrower’s credit history and financial health, including their credit score, income, and assets.

Escrow: As a homeowner, you are responsible for paying property taxes and homeowners insurance, which are managed by your lender through an escrow account. This escrow account functions like a non-interest-bearing checking account, collecting the funds your lender uses to cover these expenses. Your monthly mortgage payment includes an escrow portion, which is deposited into the escrow account by your lender to ensure timely payment of taxes and insurance.

Not all mortgages include an escrow account. If your loan doesn’t have one, you’ll need to pay your property taxes and homeowners insurance bills directly. Typically, an escrow account is required if your down payment is less than 20%.

The amount in your escrow account depends on the annual costs of your insurance and property taxes. Since these expenses can vary from year to year, your escrow payments may change, which can cause your monthly mortgage payment to increase or decrease.

Loan Servicer: A loan servicer is responsible for sending monthly mortgage statements, processing payments, managing escrow accounts, and handling borrower inquiries. In some cases, the servicer is the same company that approved your mortgage loan, but this is not always the case. Lenders may sell the servicing rights of your loan, and you may not have the option to choose your new servicer.

Mortgage Note: A mortgage note is a legal document that outlines the terms of a loan used to purchase a property. It acts as an IOU and details repayment specifics, including the interest rate, whether it’s adjustable or fixed, the total loan amount, and the loan term (the duration for repayment). After the loan is fully repaid, the homeowner receives the mortgage note.

Making Homeownership Achievable

Becoming a homeowner demands money, time, and effort, but for motivated buyers, it’s a rewarding endeavor. Take the time to understand every aspect of a mortgage to make an informed decision on one of the biggest financial investments you may ever make.