What Is a Mortgage Loan?

What Is a Mortgage Loan?

A mortgage is a type of loan used to purchase a home

Since most homebuyers do not have hundreds of thousands in cash on hand, the majority of consumers use mortgage loans to purchase their properties. This allows them to spread the cost of the home out over time — often many decades.

According to the National Association of REALTORS®, a whopping 87% of all 2020 homebuyers used a mortgage to purchase their home. Among 22 to 30-year-olds, the share was 98%.  

Are you considering using a mortgage to buy a house? Here’s what you need to know.

How mortgage loans work

Mortgages are loans. You borrow money from a mortgage lender, which is then used to secure the house you want to buy. 

Once you’re in the home, you pay your mortgage lender back monthly — plus interest — until the entire loan is paid off.

The exact amount you’ll pay to borrow those funds depends on the loan amount, the interest rate you receive, the length of your loan, and how quickly you pay it off. Typically, the lowest interest rates are reserved for borrowers with the best credit scores (on a scale of 300 to 850).

Types of mortgage loans

There are several types of mortgage loans to choose from when buying a house. The right fit really depends on your credit score, the price range you’re looking to buy in, and a few other details.

Here are the types of loans you might consider:

  1. FHA loans: These are often used by first-time homebuyers. They have low credit score requirements, and down payments go down to 3.5% of the loan amount. 
  2. Conventional loans: These are typically reserved for higher-credit borrowers. Their down payment requirements are a minimum 3%.
  3. VA loans: VA loans — or Veterans Affairs loans — are mortgages for military service members, veterans, and their surviving spouses. They have no credit score minimums and require zero down payment.
  4. USDA loans: If you’re buying a house in a more rural part of the country, a USDA loan may be an option. These require zero down payment and are backed by the U.S. Department of Agriculture. 

In many cases, you may qualify for one or more of these loans. To find out which is best for your budget and goals, talk to an experienced mortgage loan officer.

Types of mortgage rates

There are two types of mortgage rates you can choose from. The most common is the fixed rate. This means your rate is set in stone for the entirety of your loan. (If you’re given a 4% rate at closing, it will still be 4% 30 years from now).

The other option is an adjustable-rate. These are interest rates that fluctuate over time. They start at one number (usually lower than what fixed-rate loans offer), and then, after a few years pass, they move up and down based on the market. As a result, your payment may increase or decrease as well. 

Overall, adjustable-rate mortgages can be hard to predict and budget for. If you’re not planning to be in the home for long, though, they could save you significantly in interest. (You’d just want to sell the home or refinance before the rate can go up).

Mortgage terms

A mortgage’s term is its length — the period of time your payments are spread out over. The most popular mortgage term in the U.S. is the 30-year, fixed-rate, which gives you a full three decades to pay off your loan. This minimizes your monthly payment, but typically results in more long-term interest costs over time.

Fixed-rate loans also come in smaller terms, like 20-year options, for example. With adjustable-rate loans, you can usually choose between 3/1, 5/1, 7/1, and 10/1 terms. This means that your interest rate is set for the first three, five, seven, or 10 years of the loan, and then after that, it readjusts every year after.

How to get a mortgage 

To get a mortgage, you’ll need to first prep your finances and documentation. Pull your credit report, settle any late payments, and work on getting your credit score as high as it can be.

Then, gather your important financial documents, like recent tax returns, pay stubs, W-2s, and bank statements. You should also use an affordability calculator to determine your budget.

Once you’re all set, it’s time to get pre-approved for your loan. To do this, you’ll fill out a quick application, and the lender will assess whether you’re a good candidate for a mortgage. If you are, you’ll get a letter stating how much you can borrow and at what rate. You’ll use this to guide your home search.

When you’ve finally found your dream home and had an offer accepted, you’ll fill out your lender’s full application, submit your documentation, pay your closing costs, and get your keys.

Have questions?

Mortgages can be confusing — even for seasoned homebuyers. Have questions or need advice? Get in touch with an Embrace Home Loans office in your area today.

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By Aly Yale / January 21st, 2022 / Categories: / Tags:

Aly Yale

Aly J. Yale is a freelance writer focusing on real estate, mortgage, and the housing market. Her work has been featured in Forbes, Bankrate, The Motley Fool, Business Insider, The Balance, and more. Prior to freelancing, she served as an editor and reporter for The Dallas Morning News. She graduated from Texas Christian University's Bob Schieffer College of Communication with a major in radio-TV-film and news-editorial journalism. Connect with her at AlyJYale.com or on Twitter at @AlyJwriter.