What Is a Home Mortgage? Definition, Qualification, and Types

What Is a Home Mortgage?

A home mortgage is a loan given by a bank, mortgage company, or other financial institution for the purchase of a residence—a primary residence, a secondary residence, or an investment residence—in contrast to a piece of commercial or industrial property. In a home mortgage, the owner of the property (the borrower) transfers the title to the lender on the condition that the title will be transferred back to the owner once the final loan payment has been made and other terms of the mortgage have been met.

A home mortgage is one of the most common forms of debt, and it is also one of the most recommended. Because they are secured debt—an asset (the residence) acts as backing for the loan—mortgages come with lower interest rates than almost any other kind of loan that an individual consumer can find.

How a Home Mortgage Works

Home mortgages allow a much broader group of citizens the chance to own real estate, as the entire purchase price of the house doesn’t have to be provided up front. But because the lender actually holds the title for as long as the mortgage is in effect, it has the right to foreclose on the home (seize it from the homeowner, and sell it on the open market) if the borrower can’t make the payments.

A home mortgage will have either a fixed or floating interest rate, which is paid monthly along with a contribution to the principal loan amount. In a fixed-rate mortgage, the interest rate and the periodic payment are generally the same each period. In an adjustable-rate home mortgage, the interest rate and periodic payment vary. Interest rates on adjustable-rate home mortgages are generally lower than fixed-rate home mortgages because the borrower bears the risk of an increase in interest rates.

Either way, the mortgage works the same way: As the homeowner pays down the principal over time, the interest is calculated on a smaller base so that future mortgage payments apply more toward principal reduction than just paying the interest charges.

Types of Mortgages

There are different types of mortgage loans that a borrower may use to purchase a home. Generally speaking, they can be grouped into three broad categories: conventional loans, Federal Home Administration (FHA) loans, and specialty loans.

Conventional Loans

Conventional mortgage loans are not part of a specific government loan program. These loans can be conforming, meaning that they adhere to mortgage rules set by Fannie Mae and Freddie Mac, or nonconforming. Private mortgage insurance may be required for conventional loans when the borrower puts less than 20% down.

FHA Loans

FHA loans are mortgage loans issued by private lenders and backed by the federal government. Key characteristics of FHA loans include lower credit score requirements and lower down payment requirements. It’s possible to get approved for an FHA loan with a credit score as low as 580 and a down payment of 3.5% or a credit score as low as 500 and a 10% down payment.

Specialty Loans

Specialty mortgage loans are loans that don’t fit into the conventional or FHA loan categories. This includes U.S. Department of Veterans Affairs (VA) loans, which are designed for veterans and their families, and U.S. Department of Agriculture (USDA) loans, which allow borrowers in eligible rural areas to purchase homes with no down payment.

What's Included in a Mortgage Payment?

A typical mortgage payment can include four costs:

• Principal: The principal is the amount that you borrow and have to repay to your lender.
• Interest: This is the main cost that you pay to the lender for borrowing money to buy the home.
• Mortgage Insurance: Mortgage insurance is designed to protect the lender in the event that you default on the loan. Whether you pay this or not can depend on the type of loan and the size of your down payment.
• Property Taxes and Homeowners Insurance: Lenders often roll your property tax payments and homeowners insurance into your mortgage payment. Part of your monthly payment is redirected to an escrow account to pay these expenses.

These costs are separate from upfront fees that you may have to pay to purchase a home. Those include your earnest money, down payment, appraisal and inspection fees, prepaid fees, and closing costs.

How to Get a Home Mortgage

To obtain a mortgage, the person seeking the loan must submit an application and information about their financial history to a lender, which is done to demonstrate that the borrower is capable of repaying the loan. Sometimes, borrowers look to a mortgage broker for help in choosing a lender.

The process has several steps. First, borrowers might seek to get pre-qualified. Getting pre-qualified involves supplying a bank or lender with your overall financial picture, including your debt, income, and assets. The lender reviews everything and gives you an estimate of how much you can expect to borrow. Pre-qualification can be done over the phone or online, and there’s usually no cost involved.

Getting pre-approved is the next step. You must complete an official mortgage application to be pre-approved, and you must supply the lender with all the necessary documentation to perform an extensive check on your financial background and current credit rating. You’ll receive a conditional commitment in writing for an exact loan amount, allowing you to look for a home at or below that price level.

After you’ve found a residence that you want, the final step in the process is a loan commitment, which is only issued by a bank when it has approved you as the borrower, as well as the home in question—meaning that the property is appraised at or above the sales price.

When the borrower and the lender have agreed on the terms of the home mortgage, the lender puts a lien on the home as collateral for the loan. This lien gives the lender the right to take possession of the house if the borrower defaults on the repayments.

Example of Mortgage Terms

Your mortgage terms are the terms under which you agree to repay the loan to your lender. A typical mortgage term is 30 years, though some mortgage loans may have terms ranging from 10 to 25 years instead. A home equity loan that’s used to draw out your equity, for example, might have a 10-year repayment term.

Mortgage terms also include the interest rate that you pay for the loan. Say you borrow $300,000 to buy a home. You opt for a conventional, 30-year loan. Based on your credit scores and other financial details, your lender offers you a 3.5% interest rate on the loan. You put $60,000 down and pay $200 per month for property taxes and $100 per month for homeowners insurance.

The interest rate and length of repayment determine how much you’ll pay in total for the home. Using this example, you would pay $1,377.71 per month for the loan. Over a period of 30 years, you would pay $147,974.61 in interest, $72,000 in taxes, and $36,000 for insurance for a total cost of $495,974.61. This doesn't include the down payment.

The Bottom Line

A home mortgage may be the largest loan you ever take out, but it could be a necessity if you would like to buy a house or a rental property. Understanding the different types of mortgage loans, how monthly mortgage payments break down, home loan terms, and how to apply for a loan can make the home-buying process easier.