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Buying a home is a big step, one that should only be taken after educating yourself on all aspects of the purchase process, and that includes understanding how a mortgage works and what your responsibilities are. There are different types of mortgages. Interest rates change periodically. Fees and closing costs vary between lenders. Below, we break it all down.

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What is a Mortgage?

A mortgage is a loan that is used to purchase a home or other piece of real estate. It is essentially a secured loan because the property itself acts as collateral. You can apply for a mortgage at a local bank, credit union, mortgage broker, or online. There are several websites where you can apply and receive multiple offers from mortgage lenders. 

Mortgages come in different forms. For instance, with a fixed-rate mortgage, you pay a set interest rate throughout the life of the loan. Adjustable-rate mortgages have an interest rate that periodically changes based on an index that tracks the current prime rate. There are also mortgages designed for specific situations, such as FHA, VA, and USDA loans.   

The total cost of a mortgage is determined by the type of loan, the term in years, and the interest rate.  The mortgage definition includes seven aspects to look for in a mortgage:

  • Size of Loan
  • Interest Rate
  • Closing Costs
  • Annual Percentage Rate (APR)
  • Type of Interest Rate (fixed or adjustable)
  • Loan Term (Number of Years)
  • Penalties and Additional Fees

How Does a Mortgage Work?

A mortgage works like any other loan because it has the same components. There is a total amount borrowed, an interest rate, and a specific time frame in which the borrower must pay it off. The difference with a mortgage is that the borrower will own a piece of property at the end of the term. Conversely, if the borrower defaults, the property will be foreclosed on.

Is a Mortgage different from a regular loan?

From a legal perspective, a mortgage is also classified as a “lien against the property.” This classifies it as a “secured loan.” If the property is foreclosed on due to missed payments, the residents can be evicted, and the home will be resold by the lender. The proceeds from that sale will go to pay off the balance of the mortgage. 

If the proceeds from a foreclosure sale do not cover the balance owed, the borrower will still be responsible for paying that remaining debt. This can happen when the property value goes down after the initial purchase, a scenario commonly known as being “upside-down” on your home purchase, where you are paying more than what the property is worth.

The amount that you borrow to buy a home does not change when the property value goes up or down. In cases where the property value increases, the borrower can choose to sell the home for a profit. The sale proceeds pay off the outstanding balance on the mortgage and the seller gets to keep the remainder as a capital gain.

What does a Mortgage Payment Include?

A mortgage payment is composed of several components as discussed below:


This is the cost incurred for borrowing the money. The amount of interest one pays is computed based on the interest rate and the loan balances. It is the money that a bank or any other financial institution gains from lending you money and is usually paid monthly.

Property Tax

In most scenarios, property taxes are incorporated in mortgage payments. Homeowners must pay these taxes and they are computed based on the value of the home. A portion of these taxes is collected by lenders and they retain the funds in an escrow account until they are due. 

Homeowners Insurance

In a mortgage payment, there must be homeowners insurance which is financial protection against property damage by fire, wind, theft, among other hazards. Your location may also determine whether you need to get extra insurance, for instance, flood insurance. 


This refers to the original amount that was distributed from the loaner to the borrower. As you continue making your monthly payments, the mortgage principal reduces.

Private Mortgage Insurance

Private Mortgage Insurance is most common in traditional mortgage lenders and is used to back up the lender in case one defaults on the loan payments. It seems like it mostly applies when a homebuyer puts down less than 20% of the home’s purchase price. 

Getting the Best Mortgage and Qualifying for the Loan

Understanding the key points may be very helpful in making mortgage financial decisions. Below is a summary of the steps that most people find essential to getting the best mortgage rate:

  1. Check your credit score and reports
  2. Improve your credit score
  3. Ensure you have a bigger down payment
  4. A short term loan is the best
  5. Increase your income
  6. Reduce your debts
  7. Apply with several lenders
  8. Stay up to date with mortgage rates
  9. Evaluate whether discount points are ideal
  10. Avoid any big moves such as career changes

What is Mortgage Refinancing?

Mortgage refinancing is getting a new mortgage to pay off and replace the old one. Many people decide to refinance is better for them because they get to take advantage of lower interest rates, but that is not the only reason. In some cases, homeowners will refinance to get into a different type of mortgage, like switching from an adjustable-rate to a fixed rate.

The mortgage loan steps for refinancing are like taking out the original mortgage. The borrower needs to apply and go through the lender approval process. Once that has been done, the terms of the refinancing can be discussed. The old mortgage is paid off and the borrower is placed under a new contract with the updated terms. 

Unlike the first mortgage, the refinanced version will not be for the full value of the property. The borrower will have already paid a portion of that off. For instance, if the original home price was $250,000 and the borrower has $50,000 in equity, the refinancing will be for the remaining $200,000. This improves the chances of approval for the new loan.

If you already have a mortgage, continue learning about how refinancing can be a better option for you

Important Mortgage Terminology


This refers to how a mortgage loan is paid down. During the first phases, most mortgage payments are executed based on interest. After years, payments are executed to reduce debts. The shifting from making interest payments to debt payments is referred to as an amortized mortgage. 

It is a loan repayment feature that focuses on spreading out loan payments over time. You can compute your mortgage amortization using financial calculators, spreadsheet software packages, or online amortization calculators. 


The annual percentage rate (APR) showcases the true cost of your mortgage loan. It includes interest rates, points, and fees that a lender charges. It is higher than interest rates, which is why you should differentiate these terms when applying for a mortgage.

It is an essential tool that borrowers can use when comparing a variety of lenders. It is calculated by multiplying the periodic interest rate by the number of periods in a year in which an application was made.


This is a mortgage loan that conforms to the requirements to be purchased by Fannie Mae or Freddie Mac. The imperative threshold is that the loan amount does not surpass the annual determined dollar cap for your country which is set by the Federal Housing Finance Agency (FHFA). 

In 2021, the FHFA had set the limit at $548,250 for most parts of the United States. However, some expensive areas recorded a higher amount. 

Down Payment

A down payment is a borrower’s contribution when purchasing a home using a mortgage loan. It stands for the initial ownership stake in the home where the lender provides the rest of the funds required in purchasing the home. 

Most of the lenders in the market require a down payment. It also has an influence on the interest rates. When you put down a high amount, you will be subjected to lower interest rates and favorable terms. 


This is a third-party franchise that offers neutral services until parties involved in a deal come to a consensus. Escrow holds money and property and is deployed in mortgages to manage borrowers’ annual tax and insurance costs. 

It is a mandatory service in home purchase and is involved more in monthly mortgage payments than the initial home purchase. The lender deposits part of the borrower’s mortgage payment to cover taxes and insurance premiums. 

Mortgage Servicer

A mortgage servicer is involved in processing your loan payments, keeping track of your principal, managing your escrow account, and responding to your inquiries. They are different from a mortgage lender and they may or not be from the company that gave you the loan. 

They have specific policies and procedures that they are mandated to follow and they have regulations from the federal government. 


This refers to a mortgage loan that does not comply with the loan purchasing standards set by Fannie Mae and Freddie Mac. These are government-sponsored franchises that depend on Federal Housing Finance Agency (FHFA) to determine whether a loan is non-conforming. 

The two criteria to determine whether a loan is non-conforming are if it does not meet the thresholds set by the FHFA, or if it’s too large to be classified as a non-conforming loan. 

Private Mortgage Insurance

It is an arrangement made by the lender to protect them in case a borrower defaults from paying a loan. The service is offered by private insurance companies and is mostly necessitated in conventional loans. In addition, if you make a down payment that is below 20% of the home’s purchase price, most lenders will require private mortgage insurance. 

Promissory Notes

A promissory note is an agreement where a borrower agrees that the money borrowed will be repaid fully. It also states how the loan will be paid, and includes details concerning the monthly payment amount, and duration scheduled for the repayment. The lender remains with the original promissory note until a borrower has cleared paying the loan. 

Other terms to be included in the promissory note include the interest rate being charged, any collateral that will be put up, and the date and location of note issuance. 


This is when a lender evaluates your home loan application and determines the level of risk when lending you the money. Underwriting aids the lender to gauge your creditworthiness and the potential to repay the loan. 

Some of the vital requirements in the underwriting process include income verification, getting an appraisal for the house, and providing financial documentation.

In Conclusion

There is a lot of information to cover and consider before closing on a mortgage. We encourage you to use a mortgage guide as a reference for clear, concise, and relevant information at every stage of the mortgage loan process.

Mortgage FAQs

Why do people need mortgages?

Can anybody get a mortgage?

How many mortgages can I have?

What does fixed vs. variable mean on a mortgage?

What is an FHA mortgage?

How does your credit score affect your mortgage rate?