What Is a Mortgage?

Home prices can vary wildly depending on where you’re looking to buy. However, during the second quarter of 2023, the average sales price for all homes sold in the U.S. was a staggering $495,100, according to the Federal Reserve Bank of St. Louis. 

So it’s no wonder that 78% of homebuyers financed their home purchase in 2022, according to a report from the National Association of Realtors. If you’re thinking about buying a home and plan to use a mortgage loan to help you afford the purchase, here’s what you need to know.

What is a mortgage?

A mortgage is a type of loan in which the lender agrees to finance a home purchase in exchange for installment payments over a set period of time, including interest charges. 

Mortgage loans are secured, which means you’ll use the property you’re buying as collateral. In the event you fail to make payments on the loan, the mortgage lender can seize the property in foreclosure.

How does a mortgage work?

Buying a home is a long-term financial commitment, both for you and a mortgage lender. When you apply for a mortgage, the lender will run a thorough evaluation of your financial situation and creditworthiness. If you’re approved for the loan, you’ll provide the down payment (if applicable), and the lender will provide the additional funds required to buy the property. 

The lender will use the loan amount, interest rate and repayment term to calculate your monthly payments and ensure the loan is paid off by the end of the term. Your monthly payments will typically also include other costs, such as property taxes, homeowners insurance and mortgage insurance. 

As you pay down the loan’s balance and the value of the home appreciates, you’ll build equity. Until you pay off the loan in full, however, the lender maintains a lien on the property and can seize it if you fail to make payments. 

Types of mortgage loans

There are many different mortgage loan programs that can help you finance a home purchase. Here are some of the most common options available:

Conventional loans

Conventional mortgages are home loans that aren’t backed by a government agency, and they’re the most common way to finance a property. To qualify for a conventional loan, you’ll typically need a minimum credit score of 620 and a down payment of at least 3%. Note that loan terms can vary depending on the lender, type of loan and whether you’re a first-time homebuyer. 

Additionally, if you put down less than 20%, you’ll typically need to pay for private mortgage insurance (PMI), which protects the lender in the event you fail to pay back the loan. You can get rid of PMI once your loan balance reaches 80% of the home’s value.

Conventional loans can also be conforming or nonconforming. A conforming loan is one that meets standards set by Fannie Mae and Freddie Mac, which are government-sponsored enterprises that buy loans from mortgage lenders. The most common type of nonconforming loan, on the other hand, is a jumbo loan, which exceeds the maximum loan amount for conforming loans. 

Government-backed loans

Government-backed loans are mortgages that are insured by federal government agencies. There are three types of government-backed loans you can use to buy a home, including:

• FHA loans: These loans are insured by the Federal Housing Administration (FHA) and come with down payments as low as 3.5% as well as a minimum credit score requirement of 580. If you can put down 10% or more, the credit score minimum goes as low as 500. These loans also require upfront and monthly mortgage insurance, which can remain for the life of the loan in some cases.
• USDA loans: Insured by the U.S. Department of Agriculture (USDA), these loans are designed for homebuyers looking to buy a property in an eligible rural area. While there’s no down payment requirement, USDA loans come with both an upfront guarantee fee and an annual fee that can’t be canceled. You’ll typically need a credit score of 640 or above to qualify, though options are also available for borrowers with lower scores.
• VA loans: These loans are insured by the Department of Veterans Affairs (VA) and are available to eligible military service members and veterans. There’s no down payment requirement, and while the federal agency doesn’t set a minimum credit score, lenders typically look for a score of 550 or higher. There’s also no ongoing mortgage insurance fee, though you’ll have to pay an upfront funding fee.

Fixed-rate vs. adjustable-rate loans

Regardless of which type of loan program you apply for, you might be able to choose between a fixed or adjustable interest rate. With a fixed-rate mortgage loan, your interest rate will remain the same for the life of the loan. This can ensure predictable monthly payments and protect you from increasing market rates. If market rates go down, however, you’ll need to refinance your loan to take advantage of them, which can be costly.

An adjustable-rate mortgage (ARM), on the other hand, generally starts out with a fixed rate for a set period of time — usually three to 10 years. The rate is typically lower than what you’d get on a comparable fixed-rate loan. But once this fixed period ends, the rate becomes variable and can go up or down at set intervals according to market conditions and based on a market benchmark rate. 

An ARM can save you money upfront and also allow you to enjoy the benefits of decreasing interest rates without needing to refinance the loan. If market rates go up, however, so will yours. As a result, monthly payments are less predictable and can become more expensive over time if you don’t refinance into a fixed rate.

Current mortgage rates

Mortgage rates fluctuate on a daily basis and are subject to a variety of factors, including:

• Inflation
• Bond markets
• The housing market
• The overall economy

The rate for your particular mortgage loan will also depend on several factors exclusive to you. These factors often include your:

• Credit history
• Income
• Other debts
• Property’s location
• Down payment
• Interest rate type
• Loan type 
• Repayment term

A good mortgage rate is generally considered to be one that’s lower than the national average rate. In September 2023, the average APR for a 30-year fixed-rate mortgage reached 7.99% — so if you can take advantage of a lower rate than this, you’re likely getting a good deal. 

Tip: In January 2021, mortgage interest rates reached an all-time low of 2.65%, according to Freddie Mac. While rates might not drop that low anytime soon, it is possible they’ll decline from their recent high. If you’re not in a rush to buy, you may be able to save money if you wait for market rates to come down again.

Comparing mortgage rates

Before you apply for a mortgage loan, it’s important to shop around and compare interest rates from as many lenders as possible. Each lender has its own criteria for evaluating loan applicants and determining interest rates, so applying with multiple lenders can give you a better chance of securing the best offer available. 

Before you proceed, consider the benefits and drawbacks of each loan option — along with closing costs, down payment requirements and other features that are important to you. Also consider whether a fixed or adjustable rate will work best for your budget.

Comparing mortgage rates? See the best mortgage lenders for October

Interest rate vs. APR: What’s the difference?

A loan’s interest rate represents how much you’ll pay in interest over the course of a year, expressed as a percentage. The loan’s annual percentage rate (APR), on the other hand, is typically higher. It includes all of the costs of borrowing, such as interest, discount points, and any lender fees. The APR is also expressed as an annualized percentage. 

When shopping around for mortgage rates, it’s important to compare both the APRs along with interest rates. The interest rate can help you calculate your interest expenses while the APR will provide a broader view of your total borrowing costs.

Tip: When you receive a loan estimate from a lender, the interest rate will be on the first page, and the APR will be on the third.

How to apply for a mortgage

The process of applying for a mortgage starts even before you reach out to lenders. 

“Get ready to do your homework. Know your debt, income and how much you can afford. Consider your risk appetite and how long you plan to own the place before selling or refinancing,” says Adam Dejak, the national director of residential lending at Popular Bank.

If you’re ready to apply, follow these steps:

1. Prepare your credit. Even if your credit score meets the minimum requirements to get approved, it’s important to make as good an impression as possible. Check your credit score and credit reports to gauge your overall credit health and to pinpoint areas you can address. Also avoid applying for new credit for at least 12 months before you submit a mortgage application. You might also consider paying down small balances on loans and credit cards.
2. Get preapproved. Mortgage preapproval indicates the lender is tentatively willing to lend to you if you find a home to buy. When shopping for a home, having a preapproval letter can be crucial, especially if you’re competing against other buyers. That’s because it gives the seller more confidence that your financing will go through. You’ll typically need to provide some information about yourself and some documents to prove your identity, employment, income and financial situation. 
3. Go home shopping. With a preapproval letter in hand, take your time to find a home within your budget. Your loan officer or broker will give you an idea of what you can afford.  
4. Request loan estimates. Once you have a home in mind, you can submit applications with multiple lenders or work with a mortgage broker who can do it for you. You might need to provide more information — including details about the home — to get an estimate.
5. Pick a lender and complete the application. After comparing loan estimates, choose the lender that offers the best deal for your situation. When you continue the application process, the lender will likely ask for more documents to get a full picture of your credit history and financial situation. You’ll also discuss certain terms, such as the down payment and discount points. 
6. Close on the loan. If you’re approved, you’ll close on the loan. The entire closing process can take 30 to 45 days on average, depending on the lender and the complexity of the loan. You’ll also pay any closing costs during this time, which are typically 3% to 6% of the loan amount.

Tips to get the best mortgage rate

Many factors are outside of your control when it comes to mortgage interest rates. However, there are some strategies that can help you get the best possible deal. Here are some of the most impactful ones to consider:

• Before applying, take steps to improve your credit score.
• Pay down credit card balances and low-balance loans to improve your credit utilization rate and debt-to-income ratio.
• Consider a first-time homebuyer loan (if applicable), which can come with lower costs.
• Make a larger down payment on the loan.
• Consider paying discount points — a form of prepaid interest — to reduce your rate. 
• Get loan estimates from at least three to five lenders for comparison.
• Consider the advantages and disadvantages of an ARM compared to a fixed-rate mortgage.

Frequently asked questions (FAQs)

What is the minimum credit score needed to get a mortgage?

Credit score requirements can vary depending on the lender and mortgage loan program. In general, conventional loans require a score of 620 or higher. With a government-backed loan, however, you might be able to go as low as 500.

Keep in mind that the higher your credit score, the better your rate will likely be. So before you apply for a mortgage, review your credit score and credit reports to see where you stand. Consider making improvements to increase your odds of qualifying for favorable terms.

Are mortgages and home loans the same thing?

While the terms “mortgage” and “home loan” are often used interchangeably, they can refer to two different things. In general, a purchase mortgage is a type of loan you take out to finance the purchase of a home or other type of real estate. 

However, there are also other kinds of home loans. For example, home equity lines of credit (HELOCs) and home equity loans are also considered home loans and are secured by the home — though you can use the funds for any purpose you’d like. Construction loans, reverse mortgages and some rehabilitation and renovation loans can also fall under the “home loan” category.

What affects your mortgage rate?

The housing market and economic conditions can affect your mortgage rate. But there are several factors you have control over, too. Some of the more prominent factors include your:

• Credit history
• Income
• Other debts
• Down payment
• Loan type
• Repayment term

Is a fixed rate better than an adjustable rate?

“Choosing between an ARM or a fixed-rate mortgage is largely based on personal preference that takes into account your anticipated time in the home, future life goals, interest rate cycles and risk appetite,” says Dejak.

A fixed-rate mortgage can be a good fit, for instance, if you plan to live in your home for a long time and don’t want to risk interest rates increasing over time.

That said, if you want some upfront savings and plan to move or refinance your loan within the next few years, an ARM can be worth considering.

Is a 30-year better than a 15-year mortgage?

A 30-year mortgage will come with a lower monthly payment compared to a 15-year loan, making homeownership more affordable.

That said, a shorter repayment term can help you save money in the long run. Interest costs are lower because you pay off the loan quicker, and 15-year mortgages often come with lower interest rates. If you can afford a higher payment and want to maximize your interest savings, a 15-year mortgage might be a better fit.