Quick Definition

A mortgage is a loan used to purchase real estate, where the property itself serves as collateral. Payments are typically amortized over 15 or 30 years at a fixed or adjustable interest rate.

How Mortgages Work

When you buy a home, most buyers finance 80-97% of the purchase price with a mortgage. The lender provides the funds, and you repay with monthly payments that include principal, interest, property taxes, and homeowner's insurance (collectively called PITI). If you stop paying, the lender can foreclose and sell the property to recover the loan.

Most mortgages use an amortization schedule where early payments are mostly interest. Over time, the principal portion increases as the balance decreases.

Types of Mortgages

  • Fixed-Rate: Interest rate stays the same for the full term (15 or 30 years). Predictable payments.
  • Adjustable-Rate (ARM): Rate is fixed for an initial period (5, 7, or 10 years), then adjusts annually based on a benchmark index.
  • FHA: Government-backed loans requiring as little as 3.5% down. Popular with first-time buyers.
  • VA: Zero-down-payment loans for eligible military veterans and active-duty members.

Real-World Example

Example

Purchase a $400,000 home with 20% down ($80,000). Your $320,000 loan at 6.5% for 30 years has a monthly P&I payment of $2,023. Add $350/mo for taxes and $150/mo for insurance: total PITI = $2,523/month.

Frequently Asked Questions

How much house can I afford?

A common guideline is that your total monthly housing costs (PITI) should not exceed 28% of your gross monthly income. Lenders also look at your total debt-to-income ratio, which should be below 43%.

What is PMI?

Private Mortgage Insurance (PMI) is required when your down payment is less than 20%. It protects the lender if you default. PMI typically costs 0.5-1% of the loan annually and can be removed once you reach 20% equity.

Should I get a 15-year or 30-year mortgage?

A 15-year mortgage has higher monthly payments but saves significantly on total interest and builds equity faster. A 30-year mortgage has lower payments, providing more monthly cash flow flexibility.