• Picking the Right Mortgage: What's a mortgage, anyway?


Dreaming of that new home? For most of us, the path from the dream to the door requires a mortgage. What's a mortgage? Read on.

Now that we’ve guided you through getting your finances and your credit score in order, it’s time to guide you through actually getting a mortgage.

But first, the answer to a basic question:

What’s a mortgage?

A mortgage is simply a type of installment loan. Specifically, it’s an installment loan you take out to close the gap between the money you have on hand to contribute towards the cost of a home and the money you need to actually buy the home. As most of us aren’t so flush with cash that we can simply pull out our checkbook and write the seller a check for the full price, we need mortgages to realize our goals.

(Before we continue, a little trivia for you word history geeks: The word “mortgage” comes from Old French, where it was used to refer to a “pledge” (“gage”) of property or some other fixed asset to a lender of money. While the pledge is in force, both borrower and lender act as though the borrower owns the property free and clear in the eyes of the law; in other words, the actual owner (the lender) plays “dead” (“mort”) while the loan is outstanding. The pledge itself “dies” when one of two things happens: the borrower pays the lender back in full, at which point the property is said to be “unencumbered,” or the borrower fails to pay the lender back, in which case the lender takes the property in order to dispose of it and get paid back.)

A typical mortgage covers 80 percent of a home’s purchase price and is repaid in monthly installments that combine interest, or what the lender charges for using the money lent to you, and principal, or the amount actually lent. If the mortgage covers more than 80 percent of the home’s value, a lender may require that you also make payments into a special escrow account known as an impound account that is used to pay your property taxes and premiums on private mortgage insurance (PMI). You may recall from an earlier installment in this series that many lenders require borrowers who put less than 20 percent down to purchase PMI to protect against the possibility of default before the borrower’s equity reaches the 20 percent threshold.

Even if you are among those lucky few who are flush with cash, you may want to borrow some of someone else’s money instead of spending all your own on the home you want to buy. In that case, you should read on through this portion of our buyer’s guide as well in order to determine what type of mortgage is right for you.

One of the main things you wish to avoid in selecting a mortgage is paying too much for the money you borrow. For instance, if you borrow 80 percent of the price of a $200,000 house and pay it back over 30 years at 7 percent interest, you will end up paying $223,214 in interest—more than you paid for the home itself. Interest rates right now are low enough that you will probably not have to worry about that happening if your credit is in good shape, but you do need to keep in mind the effect interest rates have on both your monthly payments and the total cost of your loan. We will explore this subject in detail as we explain the types of mortgages available, their advantages and disadvantages, and how to determine what type of mortgage is right for you, in the sections that follow.