Mortgage Basics

What Is a Mortgage?

A mortgage is simply a loan, secured by a property, that finances the purchase of a home. And for the home buyer, there are multiple options available. The key is finding the one that’s right for you and your new place, which is just what our team of experienced lenders is here to help you do.

Let’s Talk About Loans…

Each type of mortgage loan has unique features and benefits as well as terms and conditions for repayment (interest rate, terms, etc.) But to start, you can group them into two main types—fixed or adjustable.

• A fixed-rate mortgage offers a consistent interest rate, which means that your total monthly payment of principal and interest remains the same for the life of the loan.

If interest rates are currently low, if you plan to stay in the home for a long time, or if you want a predictable payment amount, a fixed-rate mortgage is usually the best option. The 30-year fixed rate mortgage remains the most common mortgage loan for buyers. Just note that other terms also exist (15-, 20-, 40-year, etc.)

• An adjustable-rate mortgage, usually referred to as an ARM, has an interest rate that is initially fixed for a specific amount of time before moving to a variable rate that “adjusts” based on market conditions.

While an ARM may start off with a lower interest rate, it could increase, which can increase your payments. Borrowers may choose to go with an ARM when they don’t plan on staying in a home long term, interest rates are high when they buy, or if they expect their incomes to increase in the next few years.

The most common ARM terms are 3-1, 5-1, 7-1, 10-1, where the loan interest rate is fixed for the initial set term (e.g., 3, 5, 7, or 10 years) and then adjusts annually after the initial set term.

Conventional vs. Government-Backed Loans

Another term you’ll hear—which is more of a general classification or grouping of loans—simply refers to who is backing (or insuring) the loan. Each of these loan types include fixed or ARM options.

• A conventional loan means it’s not insured or guaranteed by a government agency and the underwriting guidelines are set by your lender.
• Conversely, a government-backed loan is guaranteed by the agency financing the loan, such as the Federal Housing Administration (FHA) or U.S. Department of Veteran’s Affairs (VA). Government-backed loans typically have lower down payment requirements than conventional loans but may have added guidelines for the borrower, such as limits on income or who’s eligible (e.g., VA loans are designed to help eligible veterans, active-duty service members, and their spouses).

Mortgage Speak

We know there are lot of new terms and acronyms that you might not be familiar with. Refer to our glossary of terms and use it as a reference guide along the way.

What About the Mortgage Payment?

Like any loan, there will be specific terms for repayment consisting of the principal (the amount you financed) and the interest (the cost to borrow the money). Both are “amortized” over the length of the loan term, meaning each month a portion of your payment is applied to principal and a portion is applied to interest.

In addition, a mortgage payment may include additional costs some buyers don’t realize, such as:

• Homeowners Insurance, which protects you (the homeowner) and the lender against financial loss resulting from wind, fire, natural disasters, or other hazards. (You may also be required to obtain specialized provisions or policies, such as separate flood insurance, depending on the location of your property.) Your insurance is usually paid out of an escrow account (see next page).
• Property Taxes, which are assessed by the county the home is located in to fund schools and other public services in the community. Taxes vary by location, so ask your real estate agent about the specifics for your area. But as noted earlier, there are tax benefits when buying—a portion, if not all, of your property taxes may be tax-deductible. Always consult your tax advisor for details on this important tax benefit. Your taxes are usually paid out of an escrow account.
• Private Mortgage Insurance (PMI), which protects your mortgage lender from financial loss if you can’t repay your loan. This is almost always required when you put less than 20% down but will be removed once you attain 20% equity in the property.

What Is an Escrow Account?

Most borrowers will also have an escrow account included with their mortgage payment that collects a monthly amount for their homeowners insurance, property taxes, and other property associated costs. These costs are paid directly by the mortgage company on an annual basis from the funds in the escrow account.

Because taxes can go up (or down) each year based on your home’s appraised value, your escrow account may increase or decrease annually resulting in a shortage or surplus—either of which may lead to a higher or lower payment. Your lender will analyze your escrow account annually to make sure they’re not collecting too much or too little.

If their analysis of your escrow account determines that they’ve collected too much money for taxes and insurance, they’ll provide an escrow refund. If their analysis shows they’ve collected too little, you’ll need to cover the difference. You may be given options to make a one-time payment or increase the amount of your monthly mortgage payment to make up for a shortage in your escrow account.

Don’t Forget Other Home-Related Expenses

Homeownership comes with additional costs that aren’t part of your mortgage payment but need to be factored into your budget. Many people may be able to comfortably afford the monthly expense of the mortgage, but they aren’t prepared for the extra costs—or increases of some bills—that often come with a home of their own, such as:

• Utilities (i.e., these may have been included in the rent payment)
• Maintenance and upkeep of the home and systems (HVAC, plumbing, electrical, painting, etc.)
• Expenses to move and furnish a new home (e.g., new appliances, more furniture, etc.)
• HOA fees (if applicable)
• Transportation costs (e.g., longer drive to work)

Up next

We’ll dive deeper into the financial planning and preparedness as well as some fundamentals to help you determine if you’re financially ready to take this next step.

Finance Fundamentals