What Is a Mortgage?
Mortgage Loan Process, Types and Payments Overview
Definition: What is a mortgage?
Here’s how a mortgage works:
Each month you pay principal and interest. The principal is the portion that’s paid down each month. The interest is the rate charged monthly by your lender. At first you pay more principal than interest. As time goes on, you pay more principal than interest until the balance is paid off.
Consumers often prefer 30-year fixed-rate mortgages because they offer the lowest stable payment for the life of the loan. Borrowers may also choose an adjustable-rate mortgage (ARM) for temporary savings over a three- to 10-year period, but after that, the rate typically changes each year.
You’re not stuck with your mortgage — you can pay it off and replace it with a mortgage refinance.
What is a mortgage refinance?
A mortgage refinance is the process of getting a new home loan to replace an existing one. Homeowners typically refinance for three reasons:
- To get a lower interest rate. When mortgage rates fall, you can save on your monthly payment by refinancing to the lowest refinance rates available.
- To pay your loan off faster. Switching from a 30-year to a 15-year term can save you thousands of dollars in interest, if you can afford the higher payment.
- To put extra money in the bank. You can convert home equity into cash with a cash-out refinance, and put the extra funds toward financial goals or home improvements.
How to qualify for a home loan
Lenders look at four aspects of your finances to assess whether you meet the minimum mortgage requirements for a mortgage preapproval:
1. Your credit scores
A credit score of 740 or higher is likely to get you the best interest rate and an easier path to mortgage approval. However, some government-backed loan programs allow you to get approved with a credit score as low as 500.
2. Your debt compared to your income
Lenders divide your monthly income by your monthly debt (including your new mortgage payment) to determine your debt-to-income (DTI) ratio.
3. We have down payment options
A large down payment shows lenders you have good savings habits and also keeps your monthly payment lower since you borrow less of your home’s price. If you’ve had rough patches in your credit history, mortgage reserves – which are just extra funds in the bank to cover mortgage payments – may mean the difference between approval and a loan denial.
4. Your income and employment history
A steady employment history for the last two years shows lenders you have the stability to afford a regular monthly payment. Keep copies of your paystubs, W-2 and federal tax returns handy – you’ll need them during the mortgage process.
10 steps to getting a mortgage
- Check your finances. Request a credit report with scores from all three major credit reporting bureaus: Equifax, Experian and TransUnion. Use a home affordability calculator to understand how much you might qualify for.
- Choose the right type of mortgage. Do you need to focus on a low down payment mortgage program? Do you want to put 20% down to avoid mortgage insurance? Knowing your real estate and financial goals can help you choose the best mortgage for your needs.
- Decide on your mortgage term. A 30-year, fixed-rate loan is the most popular choice for the lowest monthly payment. However, a shorter, 15-year fixed loan may save you thousands of dollars in interest charges, as long as your budget can handle the higher monthly payments.
- Save, save, save. Besides saving for a down payment, you’ll need cash to cover your closing costs, which could range from 2% to 6%, depending on your loan amount. Boost your emergency savings to cover unexpected repair costs and maintenance expenses. Lenders may require you to have cash reserves that could allow you to continue paying your mortgage in case you lose your job or have a medical emergency.
- Shop, shop, shop. LendingTree studies show that borrowers save money when they compare rates from at least three to five mortgage lenders. Give the same information to each lender so you’re comparing apples to apples when reviewing rate and fee quotes.
- Get a mortgage preapproval before you house hunt. A preapproval letter confirms you can get a mortgage loan to shop for homes within a set price range. Home sellers are more likely to take you seriously as a buyer if you’ve been preapproved.
- Make an offer on your dream home. Once you’ve found the perfect place, submit your best offer along with a copy of your preapproval letter. If your offer is accepted, you’ll also pay the required earnest money deposit to show your commitment to the transaction.
- Get a home inspection. Once your offer is accepted, schedule a home inspection to identify any needed repairs or major issues. Once you negotiate repairs with the seller, your lender will typically order a home appraisal to verify the home’s market value.
- Cooperate with the underwriter. Your lender’s underwriting team will ask for paperwork to verify all the information on your loan application. Be prompt in your responses to prevent delays. Once you receive final loan approval, a closing disclosure (CD) will be given to you at least three business days before your closing date. It will reflect the final costs of the transaction, including how much money you need to bring to the closing table.
- Complete your final walk-through and closing. Before you head to the mortgage closing, walk through the property to double-check that all necessary repairs were completed and that the home is ready for you. At the closing, you’ll cut a check for your down payment and closing costs, sign the closing paperwork and receive the keys to your new home.
Types of mortgage loans
A conventional loan isn’t guaranteed by any government agency and remains the most popular mortgage option. Lending rules for conventional loans are set by Fannie Mae and Freddie Mac, and borrowers with scores as low as 620 may qualify for 3% down payment financing.
Most homeowners prefer fixed-rate mortgages because they offer the financial comfort of a stable and predictable monthly payment. The 30-year fixed-rate mortgage is the most common fixed mortgage chosen, because it allows for the lowest monthly payment spread out for the longest period of time.
Borrowers that need short term savings may choose an adjustable-rate mortgage (ARM) to take advantage of lower ARM rates for the first three, five, seven or 10 years of their loan term. The 5/1 ARM is a popular choice: The rates are typically lower than current 30-year rates for the first five years and then adjust yearly until the loan is paid off.
Your military service may make you eligible for a no-down payment loan backed by the U.S. Department of Veterans Affairs (VA). There’s no mortgage insurance requirement regardless of your down payment, and qualifying guidelines are more flexible than other loan types.
First-time homebuyers with credit scores below 620 may find it easier and more cost-effective to get a loan backed by the Federal Housing Administration (FHA). Homebuyers may qualify with only a 3.5% down payment and a 580 credit score. One drawback: FHA loan limits are capped at $472,030 for a one-unit home in most parts of the U.S.
This specialized loan program is guaranteed by the U.S. Department of Agriculture (USDA) allows for no down payment financing to help low- to moderate income consumers buy homes in designated rural areas.
A second mortgage is a home loan secured by a home that will be – or already is – secured by a first mortgage. The most common types of second mortgages include home equity lines of credit (HELOCS) and home equity loans. Second mortgages can be combined with a first mortgage to buy, refinance or renovate a home.
A refinance mortgage is a home loan that replaces your current mortgage with a new one. Homeowners often refinance to lower their payment, pay their loan off faster or take cash-out for debt consolidation, home repairs or renovations.
A jumbo mortgage is part of the conventional loan family, but it’s considered “jumbo” because it exceeds the conforming loan limits set by the Federal Housing Financial Agency (FHA). For a single-family loan in 2023, any loan above $726,200 in most parts of the country would be considered a jumbo loan. Expect higher down payment, and more stringent credit and debt requirements to qualify.