For instance, if you want to purchase a home but don’t have the funds to purchase it in full at the time of the sale, you can ask a lender for a mortgage to buy the home. With this loan, you can buy the home, provided you make your monthly mortgage payment to the lender until the loan is paid off.
Alternate name: Home loan
How Does a Mortgage Work?
Your lender—the bank or institution loaning you the funds—actually pays for the property outright when you use a mortgage to purchase a home. You then pay those funds back to the lender, plus interest. Borrowers typically make a payment each month over the length of the loan. Mortgages can have shorter or longer repayment terms. They can have interest rates that stay the same or that vary over time, and they can have different criteria for eligibility. Most of these variations have to do with your preferences for repayment terms, as well as the amount of risk assumed by the lender. The most common mortgage is the fixed-rate. According to a 2022 report from the National Association of Realtors, 94% of homebuyers chose a fixed-rate mortgage. Approximately 1% chose adjustable-rate mortgages and 2% opted for other loan terms. You’ll pay off your mortgage faster and pay less in the way of cumulative interest over the life of the loan if you opt for a shorter-term loan, but this means higher monthly payments. Longer-term loans mean a lower monthly payment, but the longer pay-off period and typically higher interest rate usually equals more interest paid over time.
30-Year Mortgages vs. 15-Year Mortgages
The term of your mortgage can have a significant impact on several loan factors. Adjustable-rate loans (ARMs) have variable interest rates. They come with a set interest rate for a period of time, usually three, five, seven, or 10 years, after which time the rate can increase. This means an increased monthly payment. Adjustable-rate loans typically come with much lower interest rates than fixed-rate options initially, but they carry the added risk of future rate increases. ARMs can be a good choice if you know you won’t be in the home long, or if you’re willing to refinance into a fixed-rate loan before your low-rate period expires.
FHA Mortgage Loans
These loans are backed by the Federal Housing Administration (FHA). They require as little as 3.5% for a down payment, and they allow for credit scores as low as 500. They require that you pay a premium for mortgage insurance, both upfront and annually, over the life of the loan.
Conventional Mortgage Loans
Conventional loans are the most popular type of mortgage product. They’re increasingly popular with first-time home buyers, too, according to the National Association of Realtors (NAR). They come with fewer fees than FHA loans, but they also have more stringent credit and debt-to-income requirements. Down-payment requirements can vary widely, generally from 3% to 20%.
Other Government-Backed Loans
Other special loan programs for certain types of buyers include Department of Veterans Affairs (VA) mortgage loans and U.S. Department of Agriculture (USDA) mortgage loans. VA loans are insured by the Department of Veterans Affairs and are available only to military members, veterans, and the surviving spouses of these individuals. They require no down payment and no mortgage insurance, and they allow you to roll your closing costs into the balance of the loan. USDA loans are mortgage loans guaranteed by the USDA. They’re only available to purchase properties located in designated rural areas of the country. They require no down payment, but you’ll have to pay mortgage insurance premiums, both upfront and annually.
Requirements for a Mortgage
Every loan program has its own unique eligibility requirements.
FHA Loans
Credit score: At least 500Down payment: 3.5% (with 580 credit score) or 10% (with 500 credit score)Debt-to-income ratio: 43% or less (45% allowed in some cases)
Conventional Loans
Credit score: 620Down payment: 3% (on certain loan programs) or higher, especially for large loansDebt-to-income ratio: 43%
VA Loans
Credit score: No minimumDown payment: None (though a funding fee is required and can be rolled into the loan balance)Debt-to-income ratio: No maximum
USDA Loans
Credit score: It can depend, but generally above 640Down payment: NoneDebt-to-income ratio: 41%
How To Get a Mortgage
Mortgage lenders often differ in fees, closing costs, and even the interest rate they’re able to give you, so it’s important to shop around and get several quotes before deciding who will originate your loan. You should also ask about the down payment and any private mortgage insurance you’d be required to pay, because this will impact your upfront and long-term costs as well.
