What Is A Mortgage And How Do I Get One?

A mortgage is likely to be the largest, longest-term loan you’ll ever take out to buy the biggest asset you’ll ever own — your home. The more you understand how a mortgage works, the better equipped you should be to select the mortgage that’s right for you.

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. That means if the borrower doesn’t make monthly payments to the lender and defaults on the loan, the lender can sell the home and recoup its money.

A borrower must apply for a mortgage through their preferred lender and ensure they meet several requirements, including minimum credit scores and down payments. Mortgage applications go through a rigorous underwriting process before they reach the closing phase. Mortgage types vary based on the needs of the borrower, such as conventional and fixed-rate loans.

Who Gets a Mortgage?

Most people who buy a home do so with a mortgage. A mortgage is a necessity if you can’t pay the full cost of a home out of pocket.

There are some cases where it makes sense to have a mortgage on your home even though you have the money to pay it off. For example, sometimes mortgage properties to free up funds for other investments.

What’s The Difference Between a Loan and A Mortgage?

The term “loan” can be used to describe any financial transaction where one party receives a lump sum and agrees to pay the money back.

A mortgage is a type of loan that’s used to finance a property. A mortgage is a type of loan, but not all loans are mortgages.

Mortgages are “secured loans“. With a secured loan, the borrower promises collateral to the lender in the event that they stop making payments. In the case of a mortgage, the collateral is the home. If you stop making payments on your mortgage, your lender can take possession of your home, in a process known as foreclosure.

How does Mortgages Work?

Individuals and businesses use mortgages to buy real estate without paying the entire purchase price upfront. The borrower repays the loan plus interest over a specified number of years until they own the property free and clear.

There are four core components of a mortgage payment: the principal, interest, taxes, and insurance, referred to as “PITI.” There can be other costs included in the payment, as well.

  • Principal: The principal is the specific amount of money you borrowed from a mortgage lender to purchase a home. If you were to buy a $100,000 home, for instance, and borrow $90,000 from a lender to help pay for it, that’d be the principal you owe.
  • Interest: The interest, expressed as a percentage rate, is what the lender charges you to borrow that money. In other words, the interest is the annual cost you pay for borrowing the principal. There are other fees involved in getting a mortgage besides interest, including points and other closing costs.
  • Property taxes: Your lender typically collects the property taxes associated with the home as part of your monthly mortgage payment. The money is usually held in an escrow account, which the lender will use to pay your property tax bill when the taxes are due.
  • Homeowners insurance: Homeowners insurance provides you and your lender a level of protection in the event of a disaster, fire or other accident that impacts your property. Your lender collects the insurance premiums as part of your monthly mortgage bill, places the money in escrow and makes the payments to the insurance provider for you when the premiums are due.
  • Mortgage insurance: Your monthly mortgage payment might also include a fee for private mortgage insurance (PMI). For a conventional loan, this is type of insurance is required when a buyer puts down less than 20 percent of the home’s purchase price as a down payment.

In the early years of your mortgage, interest makes up a greater part of your overall payment, but as time goes on, you start paying more principal than interest until the loan is paid off.

Your lender will provide an amortization schedule (a table showing the breakdown of each payment). This schedule will show you how your loan balance drops over time, as well as how much principal you’re paying versus interest.

How to get mortgage?  Step by step

You’ll need to meet minimum mortgage requirements to qualify for a mortgage. Lenders typically consider the following when reviewing your mortgage application:

Here’s how to get a mortgage:

1. Get your credit score where it needs to be.

Check your credit report to make sure all the information it contains is accurate. If not, contact the credit bureau to correct it. If the information is accurate, find out your credit score.

You can get your score from the credit bureaus (for a slight fee), for free from some websites, or from your bank. Your score will be between 300 and 850, and the higher, the better. Your credit score needs to be at least 620 for a conventional loan and could be as low as 500 for an FHA loan.

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If you need to raise your score, you can most likely ignore those companies that say they can clean up your credit. Here are some examples of what it actually takes:

  • Try to use 30 percent or less of your available credit.
  • Make sure to pay your bills on time.
  • Keep older accounts open, even if you don’t use them.
  • Don’t take out any new credit accounts.

If you find any errors on your credit report, dispute them with the creditors and the credit bureaus.

2. Check your debt-to-income ratio (DTI).

Mortgage lenders want to know how much debt you have compared to your income. It’s called your debt-to-income (DTI) ratio, and the better it is, the better mortgage terms you’ll get.

Find your DTI by plugging your financial numbers into Trulia’s affordability calculator. The percentage is found by dividing your debt by your income. For example, if your total debt is $3,000 a month (including your new mortgage payment), and your gross income is $6,000 a month, your DTI would be 50%. Lenders typically prefer DTI to be no more than 36%—although some types of mortgages allow for a DTI of 50%. To lower yours, you can pay down debt or bring in more income.

3. Think about your down payment.

An ideal down payment in the eyes of a lender is 20% of the home’s purchase price. By putting down 20%, you don’t have to pay private mortgage insurance (PMI), which is usually between 0.5% and 1% of the loan. It can also make you a more attractive borrower.

But depending on the price of the home, 20% could be out of reach. In fact, most first-time homebuyers put down less than 10%. FHA loans allow down payments as low as 3.5%. And some Veterans Affairs (VA) mortgages allow for no down payment.

4. Pick the right type of mortgage.

You have a choice of several types of mortgages. One is a conventional (or a regular) loan. Of those, you can choose between a fixed-rate loan and an adjustable-rate loan. There are also government-insured loans, such as a Federal Housing Administration (FHA) loan or a Veterans Affairs (VA) loan. Each varies in terms of interest rates, down payment requirements, and other factors. Your mortgage lender can help you pick the best type for your situation.

5. Get pre-qualified for a mortgage.

Getting pre-qualified is an informal process where you just answer the lender’s questions, such as how much you make and what you owe. Based on the information you provide the lender, they’ll let you know whether you’ll qualify for a mortgage and for what amount.

The lender typically doesn’t verify your income or pull your credit report at this point, and there is no guarantee you’ll be approved for the amount in your pre-qualification results. But if you want to start looking to see what homes you could potentially purchase, it’s a good idea.

If it looks like you could afford the type of home you want, it could be a sign you’re ready to buy a house. Also, note that you don’t have to get your mortgage from the same lender with whom you pre-qualify.

6. Get pre-approved for a mortgage.

When you are serious about buying a home, you’ll want to be pre-approved for a mortgage, which is a more involved process than pre-qualification. You’ll submit paperwork that will verify your employment and income, as well as a number of other documents that detail your financial life.

You can find a list of common documents you’ll need in our guide on mortgage pre-approval. If you get pre-approved, you can let sellers know. They’ll then consider you a serious buyer.

It’s a good idea to do some mortgage-lender comparison shopping at this point. You have many choices of where to get a mortgage: banks, credit unions, mortgage lenders, mortgage brokers, and online mortgage companies.

You can use Trulia’s pre-qualification tool to connect with local lenders near you. Your real estate agent should be able to provide some references to good mortgage lenders, but it’s still good to do your own research as well. You’ll also want to apply with more than one lender to ensure you are getting the best rate.

Keep in mind that mortgage pre-approval means you are likely to get the loan. It doesn’t mean you have the loan. You’ll still need to apply and go through underwriting before you get final approval. So don’t make any large purchases or apply for new credit after you’re pre-approved and before you apply for a mortgage. And, similar to pre-qualifying, you can still apply for a loan with another lender to see if you can get a better rate.

7. Pick a mortgage lender and apply.

After you’ve found the home, you want and have your offer approved, it’s time to get official by applying for your mortgage loan. You don’t have to apply to one of the mortgages lender​s that gave you pre-approval, but if you’re happy with one of them, apply with that lender.

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If you want to keep shopping, go for it. Even a small difference in the interest rate can save you thousands of dollars over the lifetime of your loan.

There are pros and cons to each of your options. With banks, credit unions, and mortgage lenders you get personal service, but you may not get the best interest rate. Mortgage brokers will help find the best mortgage out there for you for a fee. Online mortgage companies offer fast service and a large variety of loans but may lack a personal touch.

Applying will require a lot of documents. Be prepared by gathering all of your financial info in advance (these will typically be updated versions of the same documents you needed for pre-approval), and expect to dedicate some time and patience to plenty of paperwork. Any delays in gathering your paperwork can cause delays in your closing.

8. Close on your home.

If your loan application is approved, the next step is closing on your home. The mortgage becomes official on the day you close. To be ready on the big day, you’ll need a pen and the funds for your closing costs and down payment, typically in the form of a cashier’s check.

Closing costs will be 2% to 5% of the total cost of the home, and you’ll find out the exact amount on your Closing Disclosure at least three days before you close. There will be lots of paper signing, but there shouldn’t be any surprises at this point. Sign your name, get your keys, and find out when and to whom you should make your first month’s mortgage payment.

How to qualify for a mortgage

Here are a few tips to improve your chances of qualifying and being approved for a mortgage:

  • Educate yourself. “Make sure you know what you’re getting into before applying for a loan,” Carey says. “Research how much property taxes are, what type of mortgage product best fits your needs and what kinds of first-time homebuyer assistant grants may be available.”
  • Establish a credit history and work to maintain or improve your score. “Lenders put a lot of weight on past credit performance as a good indicator of future performance,” Carey says. Strive to make all of your credit card, loan or other debt payments on time, and check your credit reports for any errors before applying for a mortgage. If you spot incorrect information (like incorrect contact info), dispute it with the credit reporting bureau as soon as possible to get it corrected. Likewise, avoid making larger purchases (like a car) and applying for new credit cards.
  • Build up savings for a sufficient down payment. “Limiting the percentage of the purchase price financed helps improve your ability to qualify for a mortgage,” Carey says. “Responsible saving practices demonstrate your ability to manage finances and reduce the overall risk involved in lending your money.”

Avoid changes to your employment status. “Quitting your job, losing your employment or switching companies might affect your qualification,” Hall says.

Important mortgage terminology to know

As you weigh your mortgage options, here are some basic terms you may encounter (and here are other key terms to know).

Amortization

Amortization describes the process of paying off a loan, such as a mortgage, in installment payments over a period of time. Part of each payment goes toward the principal, or the amount borrowed, while the other portion goes toward interest.

A typical home loan might amortize over a 15-, 20- or 30-year term, with more of the monthly paying going toward the principal over time. When a loan fully amortizes, that means it’s been paid off entirely by the end of the amortization schedule.

APR

APR, or annual percentage rate, reflects the cost of borrowing the money for a mortgage. A broader measure than the interest rate alone, the APR includes the interest rate, discount points, and other fees that come with the loan. The APR is higher than the interest rate and is a better gauge of the true cost of the loan.

Conforming

“Conforming” refers to a conforming loan, a mortgage eligible to be purchased by Fannie Mae and Freddie Mac, the government-sponsored enterprises (GSEs) integral to the mortgage market in the U.S. These standards include a minimum credit score and maximum debt-to-income (DTI) ratio, loan limit, and other requirements.

Fannie Mae and Freddie Mac buy loans from mortgage lenders to create mortgage-backed securities (MBS) for the secondary mortgage market. The lenders, in turn, use the proceeds from those sales to continue to make mortgages for borrowers.

Down payment

The down payment is the amount of a home’s purchase price a homebuyer pays upfront. Buyers typically put down a percentage of the home’s value as the down payment, then borrow the rest in the form of a mortgage. A larger down payment can help improve a borrower’s chances of getting a lower interest rate. Different kinds of mortgages have varying minimum down payments.

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Escrow

An escrow account holds the portion of a borrower’s monthly mortgage payment that covers homeowners’ insurance premiums and property taxes. Escrow accounts also hold the earnest money the buyer deposits between the time their offer has been accepted and the closing.

An escrow account for insurance and taxes is usually set up by the mortgage lender, who makes the insurance and tax payments on the borrower’s behalf. This system assures the lender that those bills are paid, and gives the borrower the convenience of paying for these expenses in small installments each month, instead of being hit with a large bill once or twice a year.

Mortgage servicer

A mortgage servicer is a company that handles your mortgage statements and all day-to-day tasks related to managing your loan after it closes. For example, the servicer collects your payments and, if you have an escrow account, ensures that your taxes and insurance are paid on time.

The servicer also steps in with relief options if you’re having trouble making payments. A service differs from a mortgage lender, which is the financial institution that loaned you the money for your home.

Non-conforming

Unlike a conforming loan, a “non-conforming” mortgage doesn’t meet the requirements that allow it to be purchased by Fannie Mae and Freddie Mac. One example of a non-conforming loan is a jumbo loan.

Private mortgage insurance

Private mortgage insurance (PMI) is a form of insurance taken out by the lender but typically paid for by you, the borrower, when your loan-to-value (LTV) ratio is greater than 80 percent (meaning you put down less than 20 percent as a down payment).

If you default and the lender has to foreclose, PMI covers some of the shortfalls between what they can sell your property for and what you still owe on the mortgage.

Promissory note

The promissory note is a legal document that obligates a borrower to repay a specified sum of money over a specified period under particular terms. These details are outlined in the note.

Underwriting

Mortgage underwriting is the process by which a bank or mortgage lender assesses the risk they would be taking by lending to a given borrower.

The underwriting process requires an application and takes into account factors like the borrower’s credit report and score, income, debt, and the value of the property they intend to buy. Many lenders follow standard underwriting guidelines from Fannie Mae and Freddie Mac when determining whether to approve a loan.

FAQs.

What is a Mortgage?

A simple definition of a mortgage is a type of loan you can use to buy or refinance a home. Mortgages are also referred to as “mortgage loans.” Mortgages are a way to buy a home without having all the cash upfront.

Who Gets A Mortgage?

Most people who buy a home do so with a mortgage. A mortgage is a necessity if you can’t pay the full cost of a home out of pocket.

How does a Mortgage Work?

When you get a mortgage, your lender gives you a set amount of money to buy the home. You agree to pay back your loan – with interest – over a period of several years. The lender’s rights to the home continue until the mortgage is fully paid off. Fully amortized loans have a set payment schedule so that the loan is paid off at the end of your term.
The difference between a mortgage and other loans is that if you fail to repay the loan, your lender can sell your home to recoup its losses. Contrast that to what happens if you fail to make credit card payments: You don’t have to return the things you bought with the credit card, though you may have to pay late fees to bring your account current in addition to dealing with negative impacts on your credit score.

Why Do People Need Mortgages?

The price of a home is often far greater than the amount of money most households save. As a result, mortgages allow individuals and families to purchase a home by putting down only a relatively small down payment, such as 20% of the purchase price, and obtaining a loan for the balance. The loan is then secured by the value of the property in case the borrower defaults.

Can Anybody Get a Mortgage?

Mortgage lenders will need to approve prospective borrowers through an application and underwriting process. Home loans are only provided to those who have sufficient assets and income relative to their debts to practically carry the value of a home over time. A person’s credit score is also evaluated when making the decision to extend a mortgage. The interest rate on the mortgage also varies, with riskier borrowers receiving higher interest rates.