What Is a Mortgage?

What Is a Mortgage?

You’ve likely heard the term “mortgage,” but you may not know what it means.

If you buy a home, it’ll likely be one of the largest purchases you’ll ever make. Homes often cost hundreds of thousands of dollars. Unless you’re lucky enough to be able to pay this large amount in cash, you’ll need a means of securing enough money to pay for the home. Most people do this by taking out a loan from a bank or credit union called a mortgage.

That is just a basic definition, though. To better understand what a mortgage is, what getting one entails, and what other fees it covers, read below.

What Exactly Is a Mortgage?

A mortgage is a loan from a financial institution, like a credit union, designed specifically to purchase a home, whether it’s a freestanding single-family house, a townhouse, a condominium, or even a vacation home. The property you buy serves as the collateral in the loan. If you fail to make your payments, your lender can foreclose on the mortgage and take possession of the property.

While some lenders may allow you to take out a mortgage for the full price of a home, most people put a down payment on the home first. This lessens the amount you borrow and saves you money on interest in the long run. For instance, say you purchase a home worth $200,000. You make a down payment of $20,000. You’ll have to finance the remaining $180,000 with a mortgage.

There are multiple aspects to every mortgage:

1. Mortgage Principal

This is the amount of money you borrow to pay for the house. In our example, the mortgage principal would be $180,000.

2. Mortgage Interest

This is the money you pay your lender for your loan. The amount will vary based on the Annual Percentage Rate (APR) of your loan, which is commonly referred to as the interest rate. The lower the interest rate, the less you’ll pay over the term, or length, of your mortgage.

Interest rates can vary based on the term of the mortgage. Generally, though not always, rates are lower for shorter mortgage terms. So, for instance, a mortgage rate for a 15-year loan might be lower than that of a 30-year loan.

There are also different types of APRs available on mortgages. If you pick an adjustable rate mortgage, you may see your rate rise or fall over time. If you pick a fixed APR, the rate will remain the same for the entire length of your loan.

3. Property Taxes

In addition to your mortgage principal and interest payments, you have to pay property taxes on your home. This is an amount set by the county, based on an assessment of your property’s worth.   To streamline payments, many people put their taxes in escrow, which we’ll define shortly.

4. Private Mortgage Insurance

Lenders often require people who make a down payment of less than 20% to purchase private mortgage insurance, referred to as PMI. PMI is a monthly fee that protects lenders from financial loss if you default on your mortgage.

So, to have the PMI requirement waived in our $200,000 house example, you would have to borrow 80% of the purchase price, which works out to less than $160,000.

What Is an Escrow Account?

An escrow account is another common option (or requirement) for mortgage borrowers. As outlined above, your lender charges you a base price on your mortgage every month that includes the principal and the interest you owe. They may also collect monthly payments that go into an escrow account to pay for additional housing costs, such as property taxes and homeowners insurance.

An escrow account is the lender’s way of ensuring these essentials get taken care of. By dividing the yearly bill by 12 and charging you throughout the year, the lender collects all the money and then makes the payment on your behalf when the bill is due.

If you don’t put these costs in escrow, you’ll be required to manage the payments on your own.  Some people have difficulty with this because they aren’t great at budgeting and setting aside money each month. That results in struggles to pay bills on time or the need to come up with a large lump sum of cash when the bill is due. In either case, not paying these bills have very negative consequences, such as lapsing on your insurance plan or having the local tax office put a lien on your home.

Finding the Right Mortgage for Your New Home

You can work with a financial institution, such as PSECU, to get a mortgage for your new home. Be sure to do your research beforehand to find the most favorable mortgage rate and the best term for you. The financial institution you work with will consider many things before approving you for a mortgage to make sure you can be trusted to make your payments. Some things the lender may ask to see include, but are not limited to:

  • Tax returns
  • Pay stubs
  • Credit history

After reviewing these documents, the lender determines whether you’re safe to lend the money to.

Talk to PSECU About Your Home Mortgage

Are you ready to pursue a mortgage to purchase your dream home? Talk to PSECU about our mortgage optionsGet in touch today to learn more, and check out our WalletWorks page for more money-saving tips.

The content provided in this publication is for informational purposes only. Nothing stated is to be construed as financial or legal advice. PSECU does not endorse any third parties, including, but not limited to, referenced individuals, companies, organizations, products, blogs or websites. PSECU does not warrant any advice provided by third parties. PSECU does not guarantee the accuracy or completeness of the information provided by third parties. PSECU recommends that you seek the advice of a qualified financial, tax, legal or other professional if you have questions.