How mortgages work: a beginner’s guide to home loans
Buying a home is one of the biggest financial decisions most people will ever make—and for many, it wouldn’t be possible without a mortgage. But how exactly does a mortgage work? If you’re new to the world of real estate or just want to better understand your options, this guide will break down the basics.
What is a mortgage?
A mortgage is a type of loan used to purchase real estate. In simple terms, it’s an agreement between you and a lender that allows you to borrow money to buy a home, with the property itself serving as collateral.
That means if you don’t repay the loan as agreed, the lender has the right to take ownership of the property through a legal process called foreclosure.
How a mortgage works
1. Applying for a mortgage
When you’re ready to buy a home, you’ll typically apply for a mortgage through a financial institution like a bank, credit union or mortgage lender. The lender will review your:
- Income
- Credit score
- Employment history
- Debt-to-income ratio
- Savings and assets
Based on this, they’ll determine the loan amount you qualify for and the interest rate.
2. Loan Approval and Terms
Once approved, you’ll receive a loan estimate outlining the terms, including:
- Loan amount – How much you’re borrowing
- Interest rate – The cost of borrowing, usually expressed as a percentage
- Loan term – How long you’ll take to repay (commonly 15 or 30 years)
- Monthly payments – Including principal, interest, taxes, and insurance (often called PITI)
3. Making Monthly Payments
Each month, you’ll make a mortgage payment that typically covers:
- Principal – The amount you borrowed
- Interest – What the lender charges for the loan
- Property taxes
- Homeowners insurance
- (Possibly) Mortgage insurance – If your down payment is less than 20%, you may be required to pay PMI (private mortgage insurance)
In the early years, a larger portion of your payment goes toward interest, while later in the loan term, more goes toward the principal.
Types of mortgages
There are several types of mortgages, each with different pros and cons:
- Fixed-Rate Mortgage: The interest rate stays the same for the entire loan term. Predictable payments.
- Adjustable-Rate Mortgage (ARM): Starts with a low rate that adjusts periodically based on market conditions.
- FHA Loan: Government-backed; easier to qualify with a lower down payment.
- VA Loan: Available to veterans and active military; no down payment required.
- Jumbo Loan: For higher-priced homes that exceed conventional loan limits.
Many other specialized loan programs are also available, especially for those with unique financial situations or specific needs.
Down Payments and Closing Costs
You’ll usually need to pay a down payment—a percentage of the home’s price up front. While 20% is traditional, many lenders accept less with mortgage insurance. You’ll also need to cover closing costs, which can include fees for the loan, appraisal, title insurance, and more (usually 2–5% of the purchase price).
What happens if you miss payments?
Missing mortgage payments can have serious consequences. After a certain number of missed payments, your lender can initiate foreclosure, potentially forcing the sale of your home. If you’re struggling to make payments, it’s crucial to contact your lender early—they may offer temporary relief or refinance options.
Final thoughts
A mortgage can be a powerful tool to help you achieve homeownership, but it’s also a long-term financial commitment. By understanding how mortgages work, you can make informed decisions, avoid costly mistakes, and set yourself up for success.
Whether you’re buying your first home or just brushing up on the basics, the more you know, the better prepared you’ll be.
Thinking of buying a home soon? Consider getting pre-approved to see how much you can afford—or talk with one of our experienced loan officers today!
