How Does a Mortgage Work?

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Point of Interest

Taking out a mortgage can feel like a complicated process, but breaking down the steps can keep you from feeling overwhelmed.

If you’re not entirely sure what a mortgage is and how it works, you’re certainly not alone. A 2019 Fannie Mae study found that many Americans don’t know what’s really required when taking out a mortgage. But, while you may be confused on the ins and outs of mortgages, the good news is that participants of that study actually overestimated the credit score and down payment needed to qualify for a mortgage. 

So, if you’ve been putting off learning about mortgages out of fear that you won’t qualify, finding a home loan may be easier than you think. You just need a quick education on how mortgage loans function before you apply.

How does a mortgage work?

Mortgages are loans used to buy a home. Borrowers can take out a mortgage for the price of a home from a lender to buy a house and then pay it back with interest in monthly payments. The lender essentially provides the funding to buy the house upfront since most people aren’t able to buy homes outright with a lump sum of cash. Once the house is purchased, the borrower begins paying the mortgage back to the lender in monthly installments that are paid over a certain number of years. Mortgage terms can range anywhere from 5 to 30 years. 

During this time, interest accrues on top of the principal amount of the loan. Fixed-rate loans will have the same monthly payment through the entire loan term because the interest rate stays the same throughout the life of the loan. Adjustable-rate mortgages, on the other hand, will have monthly payments that vary over time. 

Once someone pays back all of the original loan amount and the added interest on their home, they own it outright. 

The mortgage process

  1. Know where you — and your credit score — stand. 
  • Have you already found a home or do you want to get preapproved to figure out your budget? Preapproval is a good place to start if you have a particular lender in mind but are unsure of how much house you’ll be able to get approved for. If you’ve already found a home, you’ll need to find a lender that will qualify you for the amount you need. 
  • Do you know your credit score? You’ll need to know how your credit is faring to be successful in the mortgage loan process. You’ll need a score of at least 580 to qualify for many federally backed loans (like FHA loans) as a borrower, and about 620 to take advantage of better rates. Credit requirements also vary by lender, and some lenders offer mortgage products that are a fit for those with less than perfect credit. 
  1. Determine what kind of loan you’re looking for. 
  • How long do you plan to own your home? If you’re looking for a primary residence to hold onto for the long haul, you may want to look for a fixed-rate mortgage. If you’re planning to move in less than 10 years or are looking at an investment property, an adjustable-rate mortgage may be a better fit. 
  • Know your mortgage options. Home loans that aren’t secured by a government agency are called conventional mortgages. Conventional loans include most fixed-rate and ARM mortgage products from private lenders. Government-insured mortgages include VA home loans, FHA loans and USDA loans. These types of loans have specific eligibility requirements and often have better rates or lower down payment requirements. If your mortgage amounts to $510,400 or more, though, you may need a non-conforming mortgage, also called a jumbo loan. 
  1. Find a lender — and an interest rate. 
  • Get an idea of what you’re eligible for. Lenders can help you determine what interest rates and loan amounts you qualify for by using their online tools or going through the preapproval processes. 
  • Compare individualized rates. Shop around to figure out which lenders will offer you the best interest rates and APR. Finding the lowest possible interest rate is one of the most critical parts of the mortgage process because it has a significant impact on the amount you’ll pay over the life of the loan. 
  1. Submit your application and go through the underwriting process.
  • Send it in. Once you’ve nailed down the mortgage and lender you’re going with, you’re ready to submit your application. Once you provide all the needed documentation, the underwriting process begins. During this time, the lender assesses the risk involved in offering you the mortgage. 
  • Now you wait. The lender will verify your identity, do a hard credit check, and examine your employment history, cash savings and other financial information. They’ll also appraise your potential house before making a decision. 
  1. Get approved and get ready for move-in day. 
  • Once you get approved, it’s time to take a look at the closing costs. Within a few days of your closing date, you’ll receive a list of costs, including mortgage insurance or guarantee fees, that you’ll have to pay upfront at the closing on your house. 
  • You did it! It’s time to close on the home. Once you sign on the dotted line, you’ve got the mortgage — and you’re officially a homeowner. 

The final word 

Mortgages can be tricky to understand with so many different factors to consider, but a little education can help you get a good grasp on what the mortgage process is and how it works. Familiarize yourself with various lenders and calculate what you can afford to get started. The mortgage process is long but rewarding, and you’ll have plenty of loan and lender options to consider before you commit. Your research and time spent will be well worth it when you get the keys to your new home — and a low rate on your mortgage loan.

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Rayna Perry

Personal Finance Copywriter

Rayna Perry is a Personal Finance Copywriter at Interest.com and a Public Relations major at the University of Georgia. When not writing about personal finance, she is usually watching a great movie or creating a new playlist.