Learn / What Is a Mortgage?

What Is a Mortgage?

A mortgage is a loan used to buy a home, secured by the home itself. You repay it over time, and the lender holds a claim on the property until it is paid off.

The basic idea

You borrow money to buy a home and agree to pay it back with interest over a set number of years, usually 15 or 30. Because the loan is secured by the home, the lender can take the property if the loan is not repaid, which is why mortgage rates are lower than unsecured loans.

The four parts of a payment

A monthly mortgage payment often has four parts, called PITI:

• Principal: the amount that pays down what you borrowed.
• Interest: the cost of borrowing.
• Taxes: property taxes, usually collected monthly.
• Insurance: homeowners insurance, and mortgage insurance if your down payment is small.

Term and amortization

Most mortgages are fully amortizing, meaning each payment covers interest plus a little principal, and the balance reaches zero at the end of the term. Early on, most of the payment is interest; later, most is principal.

Where your first payment actually goes

Early payments are mostly interest, because interest is charged on the balance you still owe. On a $350,000 loan at 6.75% over 30 years, the principal and interest payment is about $2,270. In month one, roughly $1,969 is interest and about $301 goes to principal. By year ten the split is closer to even, and in the final years almost all of it reduces the balance.

This is why an extra payment applied early does far more than the same payment applied late, and why the first years of a loan build equity slowly even when the payment feels large.

Who holds your loan after closing

Two separate things happen to most mortgages, and they are easy to confuse. The loan itself can be sold to another investor, which changes who owns the debt. The servicing rights can also be sold, which changes who collects your payment and manages your escrow account. Either one can happen without your consent, and both are common.

What does not change when a loan or its servicing is sold: your rate, your term, your payment amount, and every other term in the note you signed. When servicing transfers, you receive notice from both the old and new servicer, and payments sent to the old servicer during a short grace window cannot be treated as late.

Secured debt and what the lien means

A mortgage is secured debt. The note is your promise to repay; the mortgage or deed of trust is the document that attaches a lien to the property as collateral. That lien is why mortgage rates sit well below credit card rates — the lender has a claim on a real asset if the loan is not repaid.

The lien also explains several closing requirements that otherwise seem unrelated. The lender orders an appraisal to confirm the collateral supports the loan. Title work confirms no one else has a competing claim. Hazard insurance is required because the collateral has to stay intact. Each of those exists to protect the lien position, not the borrower's budget.

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Frequently asked questions

How does a mortgage work?

You borrow money to buy a home and repay it monthly with interest over 15 to 30 years. The home secures the loan until it is paid off.

What is PITI?

Principal, interest, taxes, and insurance, the four parts of a typical monthly mortgage payment.

How much do I need to put down?

As little as 0% with VA or USDA, 3% to 3.5% with conventional or FHA, or 20% to avoid monthly mortgage insurance.

Why is almost all of my early payment going to interest?

Interest is charged on the remaining balance, which is at its largest at the start. On a $350,000 loan at 6.75%, about $1,969 of the first $2,270 payment is interest and roughly $301 reduces principal. The split shifts toward principal every month.

What happens if my mortgage is sold to another company?

Your rate, term, payment, and note terms do not change. Only the owner of the debt or the servicer collecting your payment changes. You receive written notice from both the old and new servicer before a servicing transfer takes effect.

What is the difference between the note and the mortgage?

The note is your promise to repay the money. The mortgage, or deed of trust in some states, attaches a lien to the property as collateral. The lien is why mortgage rates are far lower than unsecured credit.