What is a mortgage?
A guide to understanding types of mortgages and how they work
Grasping the ins and outs of purchasing a home can set homeowners up for long-term success. As one of the leading affordable housing providers in the United States, Habitat works with families in need of safe, affordable housing to unlock access to buyer-friendly home loans, commonly referred to as mortgages. We leverage more than four decades of organizational experience to connect homebuyers with the tools and resources needed to establish financial freedom and security.
Read on to learn more about the most common types of mortgages and the ways Habitat improves access to affordable mortgages.
What is a mortgage?
A mortgage is a common way of referring to any loan that uses real estate as collateral, meaning that a home is pledged as security for repayment and the lender can take back the home if the borrower defaults on their payments. Mortgages can be used for commercial purposes, like buying an office or a warehouse. They are also used for consumer purposes, such a buying or refinancing a home.
Most homebuyers do not have enough cash to purchase a home, so they seek a mortgage from a lender to finance the purchase price.
Let’s say Janet wants to buy a home listed at $200,000, and she has $40,000 in the bank that she is willing to put toward a down payment on the home. In order to purchase the house, Janet will require a mortgage to cover her shortfall of $160,000. Month after month, Janet will chip away at her mortgage by making payments that increase her equity in the home and decrease what she owes the lender.
Mastering the basics: terms, interest and down payments
Mortgages come in many shapes and sizes. The menu of options is long and includes different terms — the length of time a borrower has to pay off their mortgage — as well as interest rates and how much down payment is required.
The typical market home loan mortgage has a 30-year term. This means the buyer will pay off the loan every month for 360 months.
Lenders charge borrowers an interest rate to cover the costs of making the loan, to account for the time-value of money and to hedge some of the risk involved in lending large sums of money. The interest rate may be fixed or variable, and borrowers generally will be offered different rates depending on the borrower’s credit profile.
With a fixed-rate mortgage, the monthly amount for the principal remains the same for the term of the loan. With a variable or adjustable-rate mortgage, the payments adjust over the life of the loan based on fluctuating interest rates driven by market conditions.
If Janet chooses a 30-year fixed-rate mortgage at a 4.5% interest rate, she can expect to pay the same principal payment on her mortgage from the day she closes on her home until the time it’s paid off 30 years later. Her lender will likely also escrow — set aside money for — additional funds included in her monthly mortgage payment for items like taxes and insurance, which will adjust annually based on changes in actual tax and premium due. Escrows can simplify the bill-paying process for homeowners by combining principal, interest, taxes and premiums into one payment.
Exploring other mortgage options
Future homeowners may also consider other mortgage conditions like whether the loan is federally backed or held in portfolio by the lender.
Federally backed loans are insured by one of three U.S. government agencies — the Federal Housing Administration, the U.S. Department of Agriculture or the Department of Veteran Affairs. Lenders who use these government programs typically offer home loans that are favorable to homebuyers with lower credit scores and have smaller down payments. Additionally, federally backed loans generally include protections if the homeowner is struggling to pay their mortgage.
Most mortgages in the United States are sold off to secondary mortgage agencies, which require loans to meet certain standards. Mortgages held in portfolio refers to loans that are not sold off to conforming agencies, allowing lenders and borrowers to agree to more flexible mortgage terms that can open homeownership opportunities for buyers with lower credit scores or higher debt-to-income ratios. Lenders may offset this risk by charging higher fees and enforcing more stringent lapse penalties.
Becoming mortgage ready
When applying for a mortgage, lenders will review your financial portfolio — debt-to-income ratio, savings, income, credit history and credit score — to assess whether you qualify for a mortgage. Habitat partners with homebuyers to support them on their path toward mortgage readiness. Future homeowners may need to increase savings, improve credit scores, shrink debt, and create and manage budgets, positioning themselves to succeed for years to come.
Mortgage calculators can be helpful tools in understanding how much homeowners can expect to pay on a monthly basis. Habitat and many finance experts consider a homeowner paying more than 30% of their income on housing to be cost-burdened, leaving them with difficult financial choices when it comes to other needs. Homeowners with affordable mortgages enjoy a financial balance that enables them to build equity in their home while saving funds for emergencies and the future.
Habitat as an affordable mortgage leader
As an experienced affordable mortgage provider, Habitat is committed to creating homeownership opportunities for under-resourced families. We know that when families can become homeowners through affordable and responsible mortgages, the entire community benefits.
Sadly, soaring housing costs and record shortages marked by years of underbuilding have further deepened a nationwide affordability crisis. This crisis is particularly felt in underserved communities, where individuals’ lack of access to basic financial services and affordable mortgages has long created inequitable housing outcomes. With affordable homeownership opportunities becoming exceedingly more difficult to find, families need essential partners like Habitat to drive access. By improving the availability of homeownership through access to affordable mortgages, more families can experience the safety, security and joy of homeownership.