A mortgage is a loan taken out from a bank that covers that which is not paid for as part of a down payment. The home buyer (aka borrower) must pay back the loan, usually in monthly installments, over a predetermined period. When they have paid off the mortgage they own the house outright; until then, the home is collateral for the loan. 

The mortgage process has several steps, from pre-approval to signing. Credit: Cytonn Photography/Unsplash

Preapproval: Before you start home shopping, you need a preapproval letter from a mortgage lender. The lender will evaluate your finances—including your income, financial history and credit score—and issue a letter stating that you are preapproved for a loan of a specific amount and at a specific interest rate. This lets a seller know you are vouched for by a bank, and can give you an edge in a fast-paced real estate market. 

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Adjustable-rate mortgage

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Fixed-rate mortgage

Mortgage rate lock

Mortgage contingency

Note that the preapproval letter may only be valid for a specific time period, often 90 days. 

Choosing a lender: Your preapproval letter allows you to begin home shopping; once you make an offer on a property and it’s accepted by the seller, you’ll choose a mortgage lender. You could go with the bank that issued your preapproval, but it’s a good idea to shop around first. In fact, Fannie Mae found that getting multiple quotes helped more than one-third of home buyers negotiate for better loan terms. 

There are several types of lenders to choose from:

• You may want to start with a bank or credit union where you already have accounts; this spares you from having to pay a mortgage broker a fee to shop around for you. 
• Going through a mortgage broker has its advantages, though, as the brokers will search for the best rates and advise you on how to proceed. They’ll also help you organize all your documentation for the lender. 
• Direct mortgage lenders are financial institutions that approve of and provide the mortgage loan; some, like Quicken Loans, allow borrowers to do everything online. Without a broker, you’ll have to get quotes from multiple lenders yourself if you want to shop around. 
• Portfolio lenders—which use their own money to fund mortgages and do not sell off loans on the secondary market—come in handy for buyers taking out larger loans or who may have less-than-stellar credit, as their policies tend to be more flexible. 

Mortgage application

When filling out the mortgage application, you’ll share information about your income, employment, debts, assets and other finances; your credit score will be checked again as well. It’s typical for lenders to follow up with questions and ask for more documentation, like pay stubs. 

A major consideration in determining the kind of loan you qualify for is your debt-to-income ratio; debts in this calculation include mortgage, student loan, car and credit card payments. Lenders prefer to see a debt-to-income ratio below 36% (that is, no more than 36% of your income goes toward paying off debts.) 

Once all the numbers are crunched, the lender will send you a loan estimate with the terms of the mortgage you’ve qualified for. 

Types of mortgages 

There are several types of mortgages, and you can determine which is the right fit for you based on how long you plan to live in your home and what kind of loan repayments you’re comfortable making each month. 

A fixed-rate mortgage has an interest rate that will remain the same for the duration of your loan. You can take out a fixed-rate mortgage for 15 or 30 years. A 15-year loan means higher monthly payments, but also paying off the mortgage more quickly, and spending less on the interest rate; a 30-year loan will allow you to stretch out the payments over a longer period. You can also opt to make higher monthly payments on a 30-year loan if you find you’re able to pay it off more quickly. 

Adjustable-rate mortgages offer borrowers more flexibility: These loans come with interest rates that are fixed for a shorter period of time, and then increase or decrease based on market conditions. The initial interest rate you lock in is usually lower than it would be for other types of mortgages. These loans are a good fit for borrowers who don’t plan to live in the home for long. 

Buyers at the high end, and those purchasing homes in costlier areas, may need to take out jumbo loans, which are mortgages that exceed the loan limits set by the Federal Housing Finance Agency. For 2021, the jumbo loan limit nationwide is $548,250; in high cost areas, like New York City, it’s $822,375. With these loans, the application process may be more rigorous, as lenders have stricter requirements to qualify. 

Government-backed loans, by contrast, are a better fit for buyers who need more help purchasing first homes. These loans may be issued by the Federal Housing Administration, the Department of Veterans Affairs, which issues mortgages only to military personnel, veterans and their spouses, or the USDA, for buyers in rural areas. These loans tend to require smaller down payments but strong credit scores. 

Mortgage interest rates

Mortgage interest rates are a percentage of the loan you are taking out, and will be a portion of your monthly loan repayments. Your amount of unpaid interest compounds, which means it’s added to your balance every month and can therefore grow to a significant sum. You’ll pay off most of your interest before you pay off the principal on your loan. 

Naturally, borrowers want to lock in the most favorable interest rate possible, and rates fluctuate based on market conditions. They also vary based on the borrower’s own financial situation and credit score. Borrowers can lower their interest rates by purchasing points, that is, prepaid interest. One point is 1% of your mortgage balance, so the cost of purchasing points depends on the size of your loan. 

Borrowers can also refinance their mortgages to lock in a more favorable rate, which can substantially lower their monthly repayments. Borrowers may also choose to refinance if they want to change the type of mortgage they have or the amount they’re repaying each month. They can also refinance in order to take out a home equity loan in times of financial stress.