The term mortgage refers to a loan used to purchase or maintain a home, land, or other types of real estate. The borrower agrees to pay the lender over time, typically in a series of regular payments that are divided into principal and interest. The property serves as collateral to secure the loan.
A borrower must apply for a mortgage through their preferred lender and ensure they meet several requirements, including minimum credit scores and down payments. Mortgage applications go through a rigorous underwriting process before they reach the closing phase. Mortgage types vary based on the needs of the borrower, such as conventional and fixed-rate loans.
The Mortgage Process
Would-be borrowers begin the process by applying to one or more mortgage lenders. The lender will ask for evidence that the borrower is capable of repaying the loan. This may include bank and investment statements, recent tax returns, and proof of current employment. The lender will generally run a credit check, as well.
If the application is approved, the lender will offer the borrower a loan of up to a certain amount and at a particular interest rate. Homebuyers can apply for a mortgage after they have chosen a property to buy or while they are still shopping for one, a process known as pre-approval. Being pre-approved for a mortgage can give buyers an edge in a tight housing market because sellers will know that they have the money to back up their offer.
Once a buyer and seller agree on the terms of their deal, they or their representatives will meet at what's called a closing. This is the time the borrower makes their down payment to the lender. The seller will transfer ownership of the property to the buyer and receive the agreed-upon sum of money, and the buyer will sign any remaining mortgage documents.
Types of Mortgages
Mortgages come in a variety of forms. The most common types are 30-year and 15-year fixed-rate mortgages. Some mortgage terms are as short as five years while others can run 40 years or longer. Stretching payments over more years may reduce the monthly payment, but it also increases the total amount of interest the borrower pays over the life of the loan.
The following are just a few examples of some of the most popular types of mortgage loans available to borrowers.
Fixed-Rate Mortgages
With a fixed-rate mortgage , the interest rate stays the same for the entire term of the loan, as do the borrower's monthly payments toward the mortgage. A fixed-rate mortgage is also called a traditional mortgage.
Adjustable-Rate Mortgage (ARM)
With an adjustable-rate mortgage (ARM), the interest rate is fixed for an initial term, after which it can change periodically based on prevailing interest rates. The initial interest rate is often a below-market rate, which can make the mortgage more affordable in the short term but possibly less affordable long-term if the rate rises substantially.
ARMs typically have limits, or caps, on how much the interest rate can rise each time it adjust and in total over the life of the loan.
Interest-Only Loans
Other, less common types of mortgages, such as interest-only mortgage and payment-option ARMs, can involve complex repayment schedules and are best used by sophisticated borrowers.
Many homeowners got into financial trouble with these types of mortgages during the housing bubble of the early 2000s.
Reverse Mortgages
As their name suggests, reverse mortgage are a very different financial product. They are designed for homeowners 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.
Why Do People Need Mortgages?
The price of a home is often far greater than the amount of money most households save. As a result, mortgages allow individuals and families to purchase a home by putting down only a relatively small down payment, such as 20% of the purchase price, and obtaining a loan for the balance. The loan is then secured by the value of the property in case the borrower defaults.
Can Anybody Get a Mortgage?
Mortgage lenders will need to approve prospective borrowers through an application and underwriting process. Home loans are only provided to those who have sufficient assets and income relative to their debts to practically carry the value of a home over time. A person's credit score is also evaluated when making the decision to extend a mortgage. The interest rate on the mortgage also varies, with riskier borrowers receiving higher interest rates.
What Does Fixed vs. Variable Mean on a Mortgage?
Many mortgages carry a fixed interest rate. This means the rate will not change for the entire term of the mortgage (typically 15 or 30 years) even if interest rates rise or fall in the future. A variable or adjustable-rate mortgage (ARM) has an interest rate that fluctuates over the loan's life based on what interest rates are doing.
How Many Mortgages Can I Have on My Home?
Lenders generally issue a first or primary mortgage before they allow for a second mortgage. This additional mortgage is commonly known as a home equity loan. Most lenders don't provide for a subsequent mortgage backed by the same property.
Where Can I Get a Mortgage?
Mortgages are offered by a variety of sources. Banks and credit unions often provide home loans. There are also specialized mortgage companies that only deal specifically with home loans.
Mortgages Brokers
You may also employ an unaffiliated mortgage broker to help you shop around for the best rate among different lenders.