What Is a Mortgage?

Owning a home is the epitome of the American dream. In order to own a home, you’ll need the finances. And the way that many Americans get that financing is through a mortgage. But what is a mortgage? 

Mortgages are something that many people have – they’re almost as popular as credit cards. As is often the case with financial terms, though, understanding exactly what mortgages are may not be obvious. So, let’s take a closer look at how mortgages work and why you may want one.

A Mortgage is a Home Loan

Here’s what it means to take out a mortgage: you’re taking out a loan to finance the purchase of a home. In other words, it’s a home loan. As such, it funds the purchase of your new home — without needing all of the cash upfront.

It’s similar to an auto loan, so even first-time homebuyers may be more familiar with the concept than they realize. First, you make a down payment. Then, you make a set monthly payment until it’s paid off within a certain amount of time.

How Does a Mortgage Work?

Once you’re approved for a mortgage, the lender sets repayment terms and conditions. Over a set number of years, you’ll then repay the money you borrowed, along with any interest. The interest rate of a home loan is determined by current market rates and your lender. That rate will affect the total amount you pay over the lifetime of your mortgage loan.

You don’t own your home until your mortgage is paid off completely. As you make payments towards the principal of your mortgage, you’ll build equity. That equity is the amount of the home you own.

Common mortgage terms

There are a few key terms that can help take the mystery out of how home loans work.

Term
Definition
Lender
A financial institution that loans money for a home purchase
Annual percentage rate
Your mortgage interest rate plus fees
Promissory note
A legal document that says you'll repay the loan
Closing costs
Required fees to finalize your mortgage
Amortization
The process of paying the loan back through installments

Who Can Get a Home Loan?

Most people interested in purchasing a home can get a mortgage. And since most of us don’t have the funds to buy a home available upfront, home loans are necessary in order to buy a home. In short: as long as you get approved for a mortgage, you can get one. Basic eligibility requirements include a:

If you meet these requirements and a lender approves you, then you may be able to take out a home loan. The amount of money you can borrow depends on your finances and your lender.

What Are Common Types of Mortgages?

Since there are several types of home loans, it’s important to take a look at common options. Every kind of mortgage offers its own benefits, and it’s up to borrowers to decide which is the best for their needs.

Common home loans

Type of Mortgage
Details
Conventional loan
Issued by a private financial institution that typically requires 10-20% down
VA loan
Government-backed loans for active-duty military members and veterans
FHA loan
Government-backed loans with low credit and down payment requirements
USDA loan
Government-backed loans for eligible borrowers in certain rural areas
Jumbo loan
A large loan that exceeds the conforming loan limit set by FHFA

Fixed-rate vs. adjustable-rate

Home loans can also be broken down into two categories based on their interest rates.

Fixed-rate
Adjustable-rate
The interest rate is set and can't increase
The initial fixed-rate period often has low rates
The monthly payments are predictable
The interest rate could decrease during the adjustable period
Common terms include 15- and 30-year loans
Similarly, the interest rate could increase

Make sure to consider the details of all of your options before committing to a certain type of mortgage.

Understanding Your Choices

Now that you know the basics of mortgages, you’re better prepared to understand what’s involved in the process of buying a home. So, before committing to a specific home loan, decide which type is right for you and research lenders. Since the perfect mortgage for you depends on your situation, it’s important to consider all of your options before making a decision.

Ready to take the next step? Compare rates from top mortgage lenders to get started.