What is a mortgage?

Getting a mortgage means the difference between living in a rental or a home of your very own. Learn more about how they work.

  • Facebook.
  • Twitter.
  • LinkedIn.
  • Google Plus
  • Print

Mortgages are what have made home ownership possible in America and around the world. A mortgage is essentially an agreement between a borrower and a bank, where the bank lends money to the borrower for the purpose of buying a home. 

Mortgages were more difficult to obtain in earlier times, and it was developments such as the deductibility of mortgage interest (introduced in 1913) and the creation of the Federal Housing Administration in 1934, which helped more Americans own homes. 

Today more than two-thirds of Americans own homes, compared to less than 50% between 1900 and 1940.

Four Parts of a Mortgage

Most mortgages share the following common components.

The down payment: Lending banks like for borrowers to start out with an ownership stake in the property, so a down payment is usually expected. It's typically 20% of the property's purchase price, but it can be higher or lower.

Principal: This is the sum that's borrowed, or the original value of the loan. 

Interest: While the borrower benefits from a mortgage by ending up owning a home, the lender benefits by charging interest on the loan. Interest rates have been quite high at times, such as well above 12% for the average 30-year fixed-rate loan in the early 1980s, and quite low, such as below 5% for most of the time from 2010 through 2014. When taking out a mortgage, the better your credit rating, the lower the interest rates you'll be offered.

Collateral: As with many loans, mortgages entail collateral: The property itself is the collateral. If the borrower defaults, the bank repossesses the home. 

Types of Mortgages

There are a wide variety of mortgages, but here are some key distinctions to understand.

Fixed-rate or adjustable-rate: A fixed-rate mortgage sports an interest rate that remains unchanged for the duration of the loan. The interest rate for an adjustable-rate mortgage (ARM) will fluctuate, usually after an initial fixed period. For example, it might be fixed at a certain rate for the first three, five, or seven years, and then will rise or fall annually to correspond with prevailing interest rates. 

30-year or 15-year: The most common duration of a mortgage is 30 years, but 15-year loans are also common. The longer loans will have lower payments and will extract much more interest from the borrower, while shorter-term loans feature higher monthly mortgage payments, but less interest paid and faster equity building. Not many people realize it, but you're not limited to just one or the other kind of loan. Mortgages can be secured for 10 years, or 40 years, and other time periods, too. 

Eligibility

Not everyone will be approved for a mortgage, even though the house will serve as collateral. That's because most lenders want some assurance that the borrower will be able to keep up with payments. Thus, lenders use formulas to determine how much you can borrow, based on your income and debt obligations. Your credit record also factors into the decision, with a good credit history leading to more generous terms. 

Amortization

A five-syllable word to understand regarding the mortgage process is amortization. In the home-buying context, it's the process by which you make loan repayments over time, according to a fixed schedule. Typically, early payments will mostly consist of interest, and later ones will mostly consist of payments against the principal of the loan. Mortgages may be complicated, but they're well worth it if they get you into a home of your own. 

Topics:
  • Home Buying
  • Mortgages
  • Home Buying
  • Mortgages
  • Home Buying
  • Mortgages
  • Home Buying
  • Mortgages
  • Facebook.
  • Twitter.
  • LinkedIn.
  • Google Plus
  • Print
This article was written by Selena Maranjian from The Motley Fool and was licensed as an article reprint. Article copyright April 11, 2015 by The Motley Fool.
The statements and opinions expressed in this article are those of the author. Fidelity Investments cannot guarantee the accuracy or completeness of any statements or data.
This reprint is supplied by Fidelity Brokerage Services LLC, Member NYSE, SIPC.
The third party provider of the reprint permission and Fidelity Investments are independent entities and not legally affiliated.
The images, graphs, tools, and videos are for illustrative purposes only.
722767.1.0
close
Please enter a valid e-mail address
Please enter a valid e-mail address
Important legal information about the e-mail you will be sending. By using this service, you agree to input your real e-mail address and only send it to people you know. It is a violation of law in some jurisdictions to falsely identify yourself in an e-mail. All information you provide will be used by Fidelity solely for the purpose of sending the e-mail on your behalf.The subject line of the e-mail you send will be "Fidelity.com: "

Your e-mail has been sent.
close

Your e-mail has been sent.

Here's what we suggest you explore next

Taking your wallet on vacation? Here's how to keep it safe

Tourists are often targeted by pickpockets or thieves. Read here to learn how you can keep your wallet safe on vacation.

Like your checking account, but with some useful extras

All ATM fees reimbursed. No minimum balance. Pay bills. Deposit checks.

You might also like

7 ways to increase debt payoff momentum

Paying off debt routinely is not always easy. This article examines 7 ways you can increase your debt payoff momentum.

What are my student loan repayment options?

Wondering what your best options are for repaying your student loans? This article outlines the many choices you have in deciding which student loan repayment plan is right for you.

Pay off your student loans faster in 2017

Looking for ideas on how you can pay your student loans off faster in 2017? This article outlines some ways that may help you streamline your student loan debt repayment process.

2% cash back on everyday purchases1

Deposit your cash rewards into an eligible Fidelity account. No annual fees.