How Do Home Mortgages Work?

You can understand the mortgage process.

You can understand the mortgage process.

A house is probably going to be the biggest purchase you ever make, so naturally, you want to understand all the ins and outs of buying one. explains that many different types of mortgages are available, almost as many as the types of houses. Understand the choices to pick the right one for you.

Building Equity

Purchasing a home is a whole different animal than renting. When you rent, you are free of maintaining the place, but you build no equity. Every time you make a mortgage payment for most mortgages, you are building equity (ownership) in the home. The exception to this is the type of mortgage called an interest-only loan. With that type of arrangement, you only pay the interest on the mortgage and no principal for a specified time. You save money initially this way, but you don’t build any equity until you start paying principal.

The Lender

When you go to a lender to get a mortgage, the lender considers whether you qualify by examining your debt-to-income ratio, meaning how much you earn pre-tax compared to your expenses. Your monthly mortgage payment should not be more than 29 percent of your gross income, according to the Federal Housing Administration. Also, your mortgage payment combined with your other non-housing expenses, should be no more than 41 percent of your income. Lenders consider how much you can put down as a down payment. Lenders also pull up your credit report to review how well you've managed debt up to this point.

Down Payment and Closing Costs

It’s traditional to put down 20 percent of the price of the home as a down payment. That way, you won’t have to pay mortgage insurance. However, if you can’t afford that, first-time homebuyers may qualify for a down payment as low as 3.5 percent through the FHA. You should also expect to pay closing costs, which are miscellaneous fees for associated with the loan, such as processing fees and handling paperwork. You can roll these costs into your loan if you don’t have the cash to pay them. Closing costs are typically two to seven percent of the property value.

Fixed-Rate Mortgage

You have several options on the type of mortgage you select. Fixed-rate mortgages mean the mortgage payments you make remain the same each month for the life of the loan, which is typically 15 or 30 years. The advantage to a fixed rate loan is that it is predictable; your mortgage payment will not fluctuate with interest rate changes.

Adjustable-Rate Mortgage

Adjustable-rate mortgages (ARM) mean that your monthly payment can go up or down depending on the fluctuations of the market interest rates. Most ARMs start you out with a fixed rate that is typically lower than it would be for a fixed-rate mortgage. This initial period could be for a month or for 10 years, depending on your deal. ARMs with a long initial fixed period are called hybrids. For example, you can get a 5/1 ARM, meaning the fixed rate lasts for five years. After that, the rate adjusts annually. You can also get a 3/1, a 7/1 or a 10/1 ARM. Other ARMS allow you to convert your ARM to a fixed-rate at any time for a fee. Don’t assume you can do this, however. Ask your lender first.

Other Types

A balloon mortgage is one that offers a low rate in the beginning, usually for five, seven or 10 years, at which point the balance is due or eligible for refinancing. A two-step mortgage is one where the interest rate only adjusts one time and then remains the same. These mortgages may allow you to qualify for a larger home. They can be risky. Generally, people get them when they plan to move before the loan adjusts or if they are confident that they will earn more money in the future, according to the U.S. Department of Housing and Urban Development.

Pay Off Sooner

You can pay your mortgage off sooner by making an additional payment to the principal. You can indicate this, generally, by checking a box on your mortgage payment coupon. One way people do this is to add one-twelfth of the mortgage payment as the extra amount. This way, you are essentially making one extra mortgage payment a year, which means you pay your mortgage off years sooner.


Your lender might establish an escrow account for you. This is an account where a portion of your mortgage payment is set aside to cover charges, such as homeowners insurance, mortgage insurance -- if you have to pay it -- and property taxes.


About the Author

Laura Agadoni has been writing professionally since 1983. Her feature stories on area businesses, human interest and health and fitness appear in her local newspaper. She has also written and edited for a grassroots outreach effort and has been published in "Clean Eating" magazine and in "Dimensions" magazine, a CUNA Mutual publication. Agadoni has a Bachelor of Arts in communications from California State University-Fullerton.

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