How Does a Mortgage Work?

Mary Gormandy White
New homeowner signing contract of house sale or mortgage papers

When you purchase a home, you will need to take out a mortgage loan unless you have access to sufficient cash to pay for the property in full or you enter into a rent-to-own agreement. This type of loan is fairly complicated, due to the nature of real estate transactions, the fact that the home itself is used as collateral, and the typically high dollar value of the loan.

Where to Get a Mortgage

You can work directly with a mortgage lender (such as your bank or a mortgage company) or opt to work with a mortgage broker who offers access to a variety of home loan options from different lenders. In some cases, it may make sense to work with a private lender instead. Shop around to find the best deal on a mortgage you can qualify for when you are in the market for a new home.

Qualifying for a Mortgage

Consider getting pre-qualified for a mortgage before you start looking at properties so you will know exactly how much you qualify to borrow. Qualifying for a mortgage loan is based on a variety of factors related to your financial situation. Relevant factors include:

  • Length of time you have been in your current job
  • Your debt-to-income ratio
  • Your credit history
  • Your ability to make a significant down payment
  • The source of funds for your down payment

Special programs and options are sometimes available for people who may not qualify for a traditional mortgage, including first-time buyer, low-income buyers, and borrowers with lower credit scores.

Mortgage Interest

The interest rate is an important consideration when taking out a mortgage, as even what seems to be a small difference can result in a significant amount of money over the life of a home loan. Be sure to shop around for the best mortgage rate, and make sure you understand all the terms and conditions, including whether the rate is fixed or adjustable.

Mortgage Length

According to SmartAsset.com, most mortgage loans are for 15-year or 30-year terms, though loans with a term as long as 40 years do exist. Bankrate indicates that there are also home loans with terms as short as 10-years. Generally, the longer the term, the lower the payment. With shorter terms, the payment is higher but you can save a significant amount of money on interest and be free from mortgage payments much sooner.

Closing Costs

The process of closing on a home can be lengthy, as numerous steps must be completed. Examples include a title search, home appraisal, home inspection, warranty deed, and more. While the home seller typically pays some portion of the closing costs, many of the associated fees are usually paid by the buyer. Details of who pays for what will be specified in the purchase agreement. A closing cost estimator can be a helpful tool to estimate what you can expect to pay.

Mortgage Payments

The amount of your mortgage payment will be based on the total amount borrowed, the length of your loan, the interest rate, escrow payments, applicable private mortgage insurance (PMI), and any closing costs you roll into your loan. Use an amortization calculator, an amortization table or a formula to estimate your payment based on different variables.

Paying Down a Mortgage

Once you secure a mortgage, the next step will be to get started paying it down. Make sure you understand how mortgage payments work. If you want to pay it offer sooner than the term of your loan, consider accelerating your loan by making additional payments toward the principal. If you were required to take out PMI, be mindful of when you can ask to have it removed. Doing so will free up additional funds you can use to pay down your home loan, or for other purposes.

How Does a Mortgage Work?