What is a Mortgage and How Does it Actually Work?

3 March 2023

Mortgages are loans used by people to purchase a home. Like other loans, you pay back your mortgage over time with interest.

When applying for a mortgage, you’ll need to demonstrate that you can afford the monthly payments and possess enough income to service the loan. This includes your income, assets and credit history.

Lenders will want to see that you have saved up money for a down payment, such as funds from a gift or 401(k) retirement plan, or that you qualify for a down payment assistance program.

A down payment makes the mortgage process simpler, as it reduces the amount of money you must borrow. Furthermore, it increases your home equity which can be used for covering expenses like medical bills, college tuition or home improvements.

Mortgages can be paid off in as little as 25 years, but the longer you delay, the higher your interest costs will be. Your lender will provide an amortization schedule which outlines your monthly mortgage payments and the total amount of interest charged over time.

The most common mortgage type is a fixed-rate loan, in which the interest rate remains constant throughout its term. On the other hand, you can also get an adjustable-rate mortgage (ARM), which allows your payments to adjust according to market fluctuations and lower them accordingly; however, keep in mind that interest on an ARM tends to be higher than on fixed rate loans.

An ARM may be a viable option for those new to the housing market who don’t have much saved up for a down payment on a house. But in order to qualify, you’ll need both an established employment history and good credit score.

Another type of mortgage is a purchase-money mortgage, which allows you to buy a home without making a down payment. It works similarly to traditional mortgages in that the seller agrees to let you borrow the remaining funds for covering the purchase price and you provide them with documentation proving your loan.

Mortgages of this kind are usually provided by private banks and other traditional financial institutions, though they can also be issued through real estate agents or brokers. If a realtor or broker is involved, they will typically request a credit report on the buyer for verification purposes.

Once the buyer and seller have agreed on the terms of a mortgage, they enter into a contract that pledges the property as collateral. If the borrower defaults on payments, the lender has the right to repossess and sell it in order to recoup some or all of what is owed.

Obtaining a mortgage can seem overwhelming, but knowing the basics of how it works will enable you to better comprehend the procedure and make informed decisions. For instance, understanding different payment options allows you to decide whether an interest-only or fixed rate mortgage would suit your needs better.