Buying a home is one of the largest purchases most people will make in their lives, and taking out a home loan is a common way to finance the purchase. This primer on home loans explains the mortgage basics, including what a mortgage is, typical types of loans and the concept of shopping for a lender.
What Is a Mortgage?
A mortgage is a loan used to purchase a home or other type of real estate. It uses your home as collateral, which means that the lender has the right to take the title to your property if you fail to repay through mortgage payments the money you’ve borrowed.
The term mortgage may also be used to indicate the amount of money you borrow, with interest, to purchase your house. The mortgage amount is usually the purchase price of the home minus your down payment.
Your monthly mortgage payment will generally consist of principal, interest, escrow, taxes, homeowners insurance, private mortgage insurance, and homeowner’s association or condominium fees. Your mortgage servicer will combine these costs into a single, monthly payment.
Choosing a Loan Term
When choosing the right home loan for you, it’s important to consider the loan term, which is the length of time it will take you to repay your loan before you fully own your home. Your loan term will affect your interest rate, monthly payment and the total amount of interest you will pay over the life of the loan.
Long-term mortgages, such as the most common 30-year term, typically have:
- Smaller monthly payments than short-term mortgages, making your mortgage more affordable month by month.
- Higher mortgage rates, meaning you’ll pay more in interest over the life of the loan.
Short-term mortgages, which typically come in the form of 10, 15 or 20 years, generally have:
- Lower interest rates than long-term mortgages, meaning you’ll pay less interest over the life of the loan.
- Higher monthly payments than long-term mortgages.
Deciding on a Loan Type
There are two basic types of mortgages: fixed-rate mortgages and adjustable-rate mortgages. Your loan type will determine whether your interest rate and monthly payment will change over time.
Fixed-rate mortgages (FRM) lock in one interest rate for the life of the loan. This means your monthly mortgage payment will remain the same for the entire loan term. Because of the payment stability, fixed-rate mortgages are the most used loan type.
Adjustable-rate mortgages (ARM) have an interest rate that will change over the life of the loan, and rates for ARMs typically start off lower than those of a fixed-rate mortgage. After an initial hold period, ranging from six months to 10 years, your interest rate will change based on market conditions, whether higher or lower than your current rate. However, ARMs have maximums and minimums that the interest rate can change at each adjustment period, as well as over the life of the loan.
Finding a Lender
Once you determine which mortgage product best fits your financial situation and goals, it’s time to shop for a lender. Your lender is an important part of your homebuying team, and they will help guide you through the rest of the mortgage process.
Before you select a lender, it’s important to explore your options. Different lenders will offer different terms and interest rates and charge different fees for a home loan. Exploring mortgage options with multiple lenders could potentially save you thousands over the life of your loan.
You can obtain estimates from many types of lenders, including loan officers at banks and credit unions, as well as mortgage brokers and non-bank lenders. Talk to multiple lenders to find the best solution to fit your situation.
A mortgage is a long-term commitment. In addition to a lender, consider talking to a HUD-certified housing counselor to discuss the best mortgage options to reach your long-term homeownership goals.
For more information about mortgages, including how to get the best interest rate for your mortgage, visit My Home by Freddie Mac®.