How Does a Mortgage Work?
When you take out a mortgage, or home loan, you make an agreement with a lender to repay the money in monthly installments over a predetermined length of time, typically 15 or 30 years. You pay not only what you borrowed but also interest, at a rate known as your “mortgage rate.” Mortgages are secured loans, meaning you’re required to put up collateral the lender can seize if you don’t live up to your end of the bargain. In a mortgage, the collateral is the home being financed.
What Goes Into a Mortgage Payment?
When thinking about what a mortgage costs, borrowers tend to focus on mortgage rates, which can vary widely and are determined by factors including the area where you live and your personal financial situation. But your loan payment can include multiple costs — not only the interest but also loan principal, taxes and fees.
The principal is the amount of money you borrow when you take out a mortgage. As you make your loan payments, your remaining principal goes down. A typical mortgage payment consists of principal plus interest.
The interest on your mortgage is the annual cost of borrowing the money; it’s expressed as a percentage of your loan amount. A fixed-rate mortgage has an interest rate that holds steady, while the mortgage rate on an adjustable-rate loan can change over time.
Taxes & Insurance
Your lender may wrap your property taxes and homeowners insurance into your mortgage payments, keep the money in an escrow account, then pay the bills when they come due. If you buy a home with less than a 20% down payment, your monthly cost also may include mortgage insurance premiums — to protect the lender if you stop paying on your loan.
You pay a number of fees — “closing costs” — when you secure your mortgage. These charges can include an origination fee, taxes, government fees, legal costs, a title fee and an appraisal charge. You might have these fees tacked onto your loan amount so that you essentially pay for them via your monthly mortgage payments.
Types of Mortgage Loans
Conventional loans follow standards set by government-sponsored mortgage companies Fannie Mae and Freddie Mac. Conventional loans tend to have the most strict requirements, so it’s often hard for lower-income borrowers or people with credit issues to qualify for them.
When you refinance a mortgage, you take out a new loan to pay off your existing mortgage. This is usually done to capitalize on a sizable drop in mortgage rates. Depending on how much gap there is between your original rate and the new one, you might save thousands over the life of your loan.
An adjustable-rate mortgage, or ARM, has two stages. In the first phase, you pay an interest rate that doesn’t change. Then, after a certain number of years, the rate “adjusts” up or down at regular intervals, based on the movements of a benchmark interest rate, like the prime rate.
How Do I find the Best Mortgage?
Shopping around for the lowest mortgage rate can save you hundreds of dollars a month and thousands of dollars over the life of your loan. We can help you find the best interest rate possible.
Data provided by Brown Bag Media, LLC. Payments do not include amounts for taxes and insurance premiums. The actual payment obligation will be greater if taxes and insurance are included. Click here for more information on rates and product details.
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Average Mortgage Rate Trends
While you need to know what the best mortgage rates are today, it can be helpful to know how rates have been moving. If rates have been on a steady climb, it may be time to lock a rate today rather than allowing another few days — and a lower mortgage rate — to pass you by.
- 30 Year Fixed
- 15 Year Fixed
- 5 Year ARM
Mortgage Requirements: What Do I Need for a Home Loan?
To decide if you’re a worthy candidate for a mortgage, lenders need a full picture of your financial situation. Being ready to meet these mortgage requirements early can speed up the process of getting a home loan.
Proof of Income
You’ll need to provide evidence that your income is steady and sturdy enough to cover your monthly mortgage payments. Two recent pay stubs and your latest W-2 tax form will usually do the trick.
A lender won’t cover 100% of a home purchase but instead wants you to kick in cash and show you’re a good risk. A higher down payment can get you a lower mortgage rate and spare you from private mortgage insurance.
Your three-digit credit score helps lenders determine how much risk you pose as a borrower. When you can show a high credit score, a lender will be willing to give you a low mortgage rate and other favorable terms.
Lenders compare your existing debt to your income to decide whether you can handle a mortgage, too. A lower debt-to-income ratio can help you snare a better mortgage rate and faster approval for your loan.
You’ll likely need to present documentation, including bank statements, copies of rent checks (if you’re a renter), a proof-of-funds or gift letter (to answer any down payment questions), and a photo ID.
Ready to Buy a Home?
What Is a Good Credit Score for Mortgages?
Your credit score plays a critical role in determining the mortgage rate you’ll be offered, and whether a lender will even approve your mortgage. Credit scores range from 300 to 850.
Lenders will feel very confident granting you a home loan if your credit score falls into this category.
A 740 credit score is generally the threshold most lenders look for in order to feel comfortable with a borrower. Anything above that is gravy.
Many lenders will provide home loans for people with these credit scores, though those at the lower end may have trouble getting a decent mortgage rate without a hefty down payment.
A credit score in this range is generally the result of questionable credit decisions, and many lenders will want to stay away. But consumers with these scores may be able to get Federal Housing Administration (FHA) loans.
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Frequently Asked Questions (FAQ) About Mortgages
What is a mortgage?
A mortgage, or home loan, is an agreement you make with a lender. You take the lender’s money to finance a home and will pay it back, with interest, in monthly installments over a period of years, typically 15 or 30. As part of the deal, you accept that the lender can take your property if you don’t make your payments.
What are the current mortgage rates?
Mortgage rates change all the time, so they’re worth keeping regular tabs on. Bookmarking a page like this one can keep you in the loop on today’s best mortgage rates.
How much mortgage can I qualify for?
Your mortgage limit is determined by multiple factors, including your income and your other debts. Take a look at our maximum mortgage calculator to get an idea of just how much home you may be able to purchase.
How many mortgages can I have?
Most lenders will allow you to carry multiple mortgages, if you can scrape together respectable down payments for each and have good credit. An old rule of thumb was that most traditional lenders would allow borrowers to have up to four mortgages simultaneously, but there’s no actual limit.
How much can I borrow for a mortgage?
The real question is, How much should you borrow based on your income? Signing on for the biggest mortgage possible is seldom the best course of action for a borrower. Spend a few minutes with our calculator and see what you can reasonably afford.
How long are mortgages?
The number of years it will take to pay off a mortgage varies, but the most common length for a fixed-rate mortgage in the U.S. is 30 years. Shorter terms of 20, 15 and even 10 years also are available. With a shorter-term mortgage, your monthly payment will be higher but your total interest cost will be much lower than with a long-term loan.
How do I calculate the math on a mortgage?
There are multiple tools you can use to calculate how much house you can afford, how large a mortgage you may be pre-approved for, or how low a mortgage rate you might be able to lock down.
What is mortgage insurance?
If you’re unable to come up with a down payment equal to at least 20% of your home’s purchase price, you’ll be asked to pay private mortgage insurance, which protects your lender in the event you can no longer afford your mortgage and stop making your payments.
More About Mortgages
Read the latest on mortgages, the trends that shape them and the strategies that can save you money on your next home loan.