What is a mortgage?

A mortgage is a loan from a bank or other financial institution that helps a borrower purchase a home. The collateral for the mortgage is the home itself, meaning that if the borrower doesn’t make monthly payments to the lender and defaults on the loan, the bank can sell the home and recoup its money.

Who Uses a Mortgage?

Individuals and businesses use mortgages to make large real estate purchases without paying the entire purchase price up front. Over many years, the borrower repays the loan, plus interest, until she or he owns the property free and clear. Mortgages are also known as liens against property or claims on property If the borrower stops paying the mortgage, the lender can foreclose. They are a form of incorporeal right. In a residential mortgage, a homebuyer pledges their house to the bank or other type of lender, which has a claim on the house should the homebuyer default on paying the mortgage. In the case of a foreclosure, the lender may evict the home's tenants and sell the house, using the income from the sale to clear the mortgage debt.

How does a mortgage work?

When you buy a home you’ll typically put down a lump sum, called a ‘deposit’, towards the property’s purchase price. The remaining cost of your home can be paid for with a mortgage. You’ll own your home, but you must make monthly repayments on the mortgage to keep it. Your regular mortgage payments will include interest, which is what the lender charges for allowing you to borrow money. The amount of interest you pay depends on the mortgage interest rate – this is a percentage of the total amount you still owe. There are several different types of mortgages, including: First-time buyer mortgages Home mover mortgages Remortgages Buy-to-let mortgages If you want to live in the property, you’ll find that most of the mortgages available to you are repayment mortgages. This means you’ll pay off a bit of the loan every month, on top of paying interest. However, if you’re getting a buy-to-let mortgage, you’ll find most of them are interest-only. This means you’ll only pay interest each month, and you’ll still owe the amount borrowed at the end of your mortgage term.

Types of mortgages

There are several types of mortgages available to consumers. They include conventional fixed-rate mortgages, which are among the most common, as well as adjustable-rate mortgages (ARMs), and balloon mortgages. Potential homebuyers should research the right option for their needs. 1. Adjustable-rate mortgage (ARM): Under the terms of an adjustable-rate mortgage (ARM), the interest rate you’re paying may be raised or lowered periodically as rates change. ARMs may a good idea when their interest rates are particularly low compared with the 30-year fixed, especially if the ARM has a long fixed-rate period before it starts to adjust. “Some examples of an adjustable-rate mortgage would be a 5/1 ARM and or a 7/1 ARM,” said Kirkland. “In a 5/1 ARM, the 5 stands for an initial five-year period during which the interest rate remains fixed while the 1 indicates that the interest rate is subject to adjustment once per year.” During the adjustable rate portion of an ARM, the interest rate charged is typically based on a standard financial index, such as the key index rate established by the Federal Reserve or the London Interbank Offered Rate (Libor). “Adjustable-rate mortgages (ARMs) track a selected benchmark index and adjust the loan’s payments based on changing interest rates,” says John Pataky, executive vice president at TIAA Bank and head of the bank’s consumer lending and mortgage division. 2. Fixed-rate mortgage: The name of a mortgage typically indicates the way interest accrues. In the case of a fixed-rate mortgage, for instance, the interest rate is agreed upon at the time you close on the purchase and stays the same for the entire term of the loan. Fixed-rate mortgages are available in terms ranging up to 30 years, with the 30-year option being the most popular, says Kirkland. Paying the loan off over a longer period of time makes the monthly payment more affordable. But no matter which term you prefer, the interest rate will not change for the life of the mortgage. For this reason, fixed-rate mortgages are good choices for those who prefer a stable monthly payment. 3. FHA mortgage: An FHA loan is a government-backed mortgage insured by the Federal Housing Administration. “This loan program is popular with many first-time homebuyers,” says Kirkland. “FHA home loans require lower minimum credit scores and in some cases lower down payments, with the average down payment being 3.5 percent.” Although the government insures the loans, these loans are offered by FHA-approved mortgage lenders. 4. Balloon mortgage: Under the terms of a balloon mortgage, payments will start low and then grow or “balloon” to a much larger lump-sum amount before the loan ends. This type of mortgage is generally aimed at buyers who will have a higher income toward the end of the loan or borrowing period then at the outset. It also may be a good approach for those who plan to sell the property prior to the end of the loan period. For those who don’t intend to sell, a balloon mortgage may require refinancing in order to stay in the property. “Buyers who choose a balloon mortgage may do so with the intention of refinancing the mortgage when the balloon mortgage’s term runs out,” says Pataky “Overall, balloon mortgages are one of the riskier types of mortgages.” 5. VA mortgage: The VA loan is a loan guaranteed by the U.S. Department of Veterans Affairs that requires little or no money down. It is available to veterans, service members and eligible military spouses. The loan itself isn’t actually made by the government, but it is backed by a government agency, which is designed to make lenders feel more comfortable in offering the loan. As a result of the government backing, lenders often offer these loans without requiring a down payment and with looser credit parameters.