REAL ESTATE & MORTGAGES

What Is a Home Mortgage?

A home mortgage is a loan given by a bank, mortgage company, or other financial institution for the purchase of a residence—a primary residence, a secondary residence, or an investment residence—in contrast to a piece of commercial or industrial property. In a home mortgage, the owner of the property (the borrower) transfers the title to the lender on the condition that the title will be transferred back to the owner once the final loan payment has been made and other terms of the mortgage have been met.

A home mortgage is one of the most common forms of debt, and it is also one of the most recommended. Because they are secured debt—an asset (the residence) acts as backing for the loan—mortgages come with lower interest rates than almost any other kind of loan that an individual consumer can find.

How a Home Mortgage Works

Home mortgages allow a much broader group of citizens the chance to own real estate, as the entire purchase price of the house doesn’t have to be provided up front. But because the lender actually holds the title for as long as the mortgage is in effect, it has the right to foreclose on the home (seize it from the homeowner, and sell it on the open market) if the borrower can’t make the payments.

A home mortgage will have either a fixed or floating interest rate, which is paid monthly along with a contribution to the principal loan amount. In a fixed-rate mortgage, the interest rate and the periodic payment are generally the same each period. In an adjustable-rate home mortgage, the interest rate and periodic payment vary. Interest rates on adjustable-rate home mortgages are generally lower than fixed-rate home mortgages because the borrower bears the risk of an increase in interest rates.

Either way, the mortgage works the same way: As the homeowner pays down the principal over time, the interest is calculated on a smaller base so that future mortgage payments apply more toward principal reduction than just paying the interest charges.

Types of Mortgages

Conventional Loans

Conventional mortgage loans are not part of a specific government loan program. These loans can be conforming, meaning that they adhere to mortgage rules set by Fannie Mae and Freddie Mac, or nonconforming. Private mortgage insurance may be required for conventional loans when the borrower puts less than 20% down.

FHA Loans

FHA loans are mortgage loans issued by private lenders and backed by the federal government. Key characteristics of FHA loans include lower credit score requirements and lower down payment requirements. It’s possible to get approved for an FHA loan with a credit score as low as 580 and a down payment of 3.5% or a credit score as low as 500 and a 10% down payment.

Specialty Loans

Specialty mortgage loans are loans that don’t fit into the conventional or FHA loan categories. This includes U.S. Department of Veterans Affairs (VA) loans, which are designed for veterans and their families, and U.S. Department of Agriculture (USDA) loans, which allow borrowers in eligible rural areas to purchase homes with no down payment.

Fixed-Rate Mortgages

The most common form of mortgage is the fixed-rate mortgage. In this type of mortgage, the interest rate remains unchanged throughout the loan’s entire term, ensuring consistent monthly payments for the borrower. It is often referred to as a traditional mortgage.

Adjustable-Rate Mortgage (ARM)

An adjustable-rate mortgage (ARM) initially features a fixed interest rate for a set term, after which it can fluctuate periodically in response to prevailing interest rates. Usually, the initial interest rate is lower than the prevailing market rates, making the mortgage more budget-friendly in the short run. However, over time, if the rate experiences significant increases, it may become less affordable.

ARMS often come with safeguards, referred to as caps, which limit how much the interest rate can rise during each adjustment period and over the entire loan duration.

Interest-Only Loans

Less prevalent mortgage options, like interest-only mortgages and payment-option ARMs, may encompass intricate repayment structures and are most suitable for financially astute borrowers. These loan categories might entail a substantial balloon payment at their conclusion.

During the housing boom of the early 2000s, numerous homeowners encountered financial difficulties due to these mortgage types.

Reverse Mortgages

As their name suggests, reverse mortgages are a very different financial product. They are designed for homeowners age 62 or older who want to convert part of the equity in their homes into cash.

These homeowners can borrow against the value of their home and receive the money as a lump sum, fixed monthly payment, or line of credit. The entire loan balance becomes due when the borrower dies, moves away permanently, or sells the home.

Average Mortgage Rates

The cost of your mortgage hinges on several factors, including the mortgage type (fixed or adjustable), its duration (e.g., 20 or 30 years), any upfront discount points paid, and the prevailing interest rates. Interest rates can fluctuate weekly and may vary between lenders, so it’s advisable to explore different options.

In 2020, mortgage rates reached near-historic lows, hitting an average of 2.66% for a 30-year fixed-rate mortgage during the week of December 24, 2020. Throughout 2021, rates remained relatively stable but have begun a gradual ascent since December 3, 2021, as indicated in the chart below. As of July 2022, the Federal Home Loan Mortgage Corp. reported average interest rates as follows:

30-year fixed-rate mortgage: 5.30%
15-year fixed-rate mortgage: 4.45%
5/1 adjustable-rate mortgage: 4.19%

These rates provide valuable insights for potential homebuyers or those looking to refinance their mortgages.

What's Included in a Mortgage Payment?

A typical mortgage payment can include four costs:

Principal: The principal is the amount that you borrow and have to repay to your lender.
Interest: This is the main cost that you pay to the lender for borrowing money to buy the home.
Mortgage Insurance: Mortgage insurance is designed to protect the lender in the event that you default on the loan. Whether you pay this or not can depend on the type of loan and the size of your down payment.
Property Taxes and Homeowners Insurance: Lenders often roll your property tax payments and homeowners insurance into your mortgage payment. Part of your monthly payment is redirected to an escrow account to pay these expenses.

These costs are separate from upfront fees that you may have to pay to purchase a home. Those include your earnest money, down payment, appraisal and inspection fees, prepaid fees, and closing costs.

What is the purpose of obtaining a mortgage?

The cost of a home frequently surpasses the savings held by the majority of households. Therefore, mortgages enable individuals and families to acquire a home with a relatively modest initial payment, typically around 20% of the property’s purchase price, while securing a loan for the remaining amount. This loan is backed by the property’s value, serving as collateral in case the borrower fails to meet their obligations.

Is it possible for anyone to secure a mortgage?

Mortgage lenders follow a comprehensive application and underwriting process to approve potential borrowers. To secure a home loan, individuals must demonstrate sufficient assets and income relative to their debts, ensuring their ability to sustain homeownership. The evaluation of an individual’s credit score plays a pivotal role in the mortgage approval process, and riskier borrowers may face higher interest rates.

Diverse sources offer mortgages, including traditional banks and credit unions, as well as specialized mortgage companies exclusively focused on home loans. Additionally, individuals can enlist the services of an independent mortgage broker to assist in comparing rates across various lenders and finding the most favorable terms.

What is the limit on the number of mortgages I can have for my home?

Lenders typically grant a primary mortgage before considering a second mortgage, often referred to as a home equity loan. It’s uncommon for lenders to approve multiple mortgages on the same property. However, there is no strict restriction on the number of junior loans you can secure for your home, as long as you meet the requirements for equity, debt-to-income ratio, and credit score approval.

What's the origin of the term "mortgage"?

The term “mortgage” originates from Old English and French, where it signifies a “death pledge.” This label reflects the fact that this form of loan is considered complete or “ends” when it’s fully repaid or in case of borrower default.

How to Get a Home Mortgage

To obtain a mortgage, the person seeking the loan must submit an application and information about their financial history to a lender, which is done to demonstrate that the borrower is capable of repaying the loan. Sometimes, borrowers look to a mortgage broker for help in choosing a lender.

The process has several steps. First, borrowers might seek to get pre-qualified. Getting pre-qualified involves supplying a bank or lender with your overall financial picture, including your debt, income, and assets. The lender reviews everything and gives you an estimate of how much you can expect to borrow. Pre-qualification can be done over the phone or online, and there’s usually no cost involved.

Getting pre-approved is the next step. You must complete an official mortgage application to be pre-approved, and you must supply the lender with all the necessary documentation to perform an extensive check on your financial background and current credit rating. You’ll receive a conditional commitment in writing for an exact loan amount, allowing you to look for a home at or below that price level.

After you’ve found a residence that you want, the final step in the process is a loan commitment, which is only issued by a bank when it has approved you as the borrower, as well as the home in question—meaning that the property is appraised at or above the sales price.

When the borrower and the lender have agreed on the terms of the home mortgage, the lender puts a lien on the home as collateral for the loan. This lien gives the lender the right to take possession of the house if the borrower defaults on the repayments.

Example of Mortgage Terms

Your mortgage terms are the terms under which you agree to repay the loan to your lender. A typical mortgage term is 30 years, though some mortgage loans may have terms ranging from 10 to 25 years instead. A home equity loan that’s used to draw out your equity, for example, might have a 10-year repayment term.

Mortgage terms also include the interest rate that you pay for the loan. Say you borrow $300,000 to buy a home. You opt for a conventional, 30-year loan. Based on your credit scores and other financial details, your lender offers you a 3.5% interest rate on the loan. You put $60,000 down and pay $200 per month for property taxes and $100 per month for homeowners insurance.

The interest rate and length of repayment determine how much you’ll pay in total for the home. Using this example, you would pay $1,377.71 per month for the loan. Over a period of 30 years, you would pay $147,974.61 in interest, $72,000 in taxes, and $36,000 for insurance for a total cost of $495,974.61. This doesn’t include the down payment.

What Is a Mortgage for a House?

A home mortgage is a mortgage loan that’s used to buy a house. The house acts as collateral for the loan. If the buyer defaults on the loan, the lender can initiate foreclosure proceedings to take possession of the property.

Is a Mortgage the Same as a Home Loan?

The terms mortgage and home loan are often used interchangeably, but they don’t exactly mean the same thing. A mortgage is a loan that’s used to buy a piece of property that’s secured by the property itself. A home loan is a type of mortgage that’s used specifically to purchase a house.

What Credit Score do You Need to Buy a House?

The exact answer for what credit score you need to buy a house can depend on the type of loan and the lender’s requirements. For example, it’s possible to get a Federal Housing Administration loan with a credit score as low as 500, but if you’re applying for a conventional loan, the lender might require a credit score of 620 or higher.

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