What Is A Mortgage? Loan Basics For Beginners

If you’re contemplating homeownership and wondering how to get started, you’ve come to the right place. We’re covering all the mortgage basics, including loan types, mortgage lingo, the home buying process and more.

Let’s start with the definition that explains what a mortgage is.

A mortgage is a loan from a lender that gives borrowers the money they need to buy or refinance a home. The borrower agrees to pay back the lender with monthly mortgage payments that include principal, interest and other fees.

Mortgages are secured loans, and secured loans are backed by collateral. In the case of a mortgage, the collateral is the home. If a borrower falls behind on their loan payments or fails to meet other mortgage terms, the mortgage loan agreement gives a lender the right to repossess the home.

When you get a mortgage, your lender provides a set amount of money to buy a home. You agree to pay back your loan with interest over several years. The lender's rights to the home remain until the mortgage is fully paid off. Fully amortized loans have a set payment schedule that ensures the loan is paid off by the end of the loan’s term.

Mortgages differ from some other loans in a distinctive way. If you can’t repay your mortgage loan, your lender can sell your home to recoup its losses. But that’s not the case if you fail to make personal loan payments, for example. Since personal loans are unsecured, you don’t have to worry about losing your home or any other asset if you fall behind on payments.

Who Are The Parties Involved In A Mortgage?

Several parties can take part in a mortgage transaction: a mortgage lender, a borrower and maybe even a co-signer.

Mortgage Lender

A mortgage lender is a financial institution that provides the money to buy a home. Your lender may be a bank, a credit union or an online company like Rocket Mortgage^®.

When you apply for a mortgage, your lender reviews your finances and credit history – including your credit score, income, assets and debt – to confirm that you can afford your loan payments and verify that you meet lender and loan requirements.

Borrower

The borrower is the person in need of a loan to buy a home. You can apply as the only borrower or apply with a co-borrower. Adding more borrowers to a mortgage can increase the total amount you can borrow. Combining everyone’s income will likely help you qualify for a more expensive home.

Co-Signer

A lender may ask a borrower to get a co-signer for a mortgage because their credit history is weak or they have no credit history. While the co-signer has no ownership rights, they agree to share the financial responsibility of repaying the mortgage if the primary borrower defaults on the loan.

Your monthly mortgage payment, which is the amount you pay every month toward your mortgage, has four major components: principal, interest, taxes and insurance (PITI).

Principal

Principal is the total amount you borrowed from the lender. A portion of each monthly mortgage payment you make pays down the principal amount.

If you want to pay off your loan early, consider making extra payments to chip away at your principal balance faster. You’ll reduce the amount you owe and pay less interest.

Interest

Interest is the cost of borrowing money. How much you pay in interest each month is based on your interest rate and loan principal. Your interest payments go directly to your mortgage lender. As your loan matures, you’ll pay less interest because your principal balance is shrinking.

Taxes And Insurance

If your loan has an escrow account, it will collect your property taxes and homeowners insurance as part of your monthly mortgage payment. Your lender will keep the money for your taxes and insurance premiums in the escrow account and pay them when they’re due.

Mortgage Insurance

Most borrowers pay mortgage insurance if they make a down payment that’s less than 20%.

Conventional loans require private mortgage insurance (PMI). Federal Housing Administration (FHA) loans require a one-time upfront mortgage insurance premium (UFMIP) and monthly MIP payments, no matter how much you put down on a home. Department of Veterans Affairs (VA) loans have a funding fee borrowers can fold into their mortgage. U.S. Department of Agriculture (USDA) loans have an upfront and monthly guarantee fee.

PMI

Private mortgage insurance (PMI) protects lenders when a borrower defaults on a conventional loan. Borrowers typically pay PMI when their down payment is less than 20%. Borrowers can usually request to remove PMI when they reach the 20% threshold through their mortgage payments and have a loan-to-value ratio (LTV) of 80%. That 20% threshold means you have 20% equity in your home.

PMI typically costs 0.2% – 2% of your total loan amount. The premium can be added to your monthly mortgage payment, covered with a one-time upfront payment at closing or covered through a combination of these payment methods. There’s also lender-paid PMI. With this arrangement, a lender pays a borrower’s PMI in exchange for charging a higher interest rate on the mortgage.

MIP

With an FHA loan, you’ll pay an upfront mortgage insurance premium (MIP) no matter how much money you put down. You’ll pay monthly MIP for the first 11 years of the loan if you make at least a 10% down payment. If your down payment is less than 10%, you’ll pay monthly MIP for the life of the loan.

If you’re a salaried employee with a good credit score and your income meets a loan or lender’s criteria, the mortgage loan process should be straightforward.

Here’s a rundown of the steps you’ll need to take to get a mortgage and become a homeowner:

1. Get Preapproved

While getting preapproved is optional, you’ll need a preapproval to be taken seriously by real estate agents and sellers in today’s real estate market.

It’s a good idea to get initial approval from a mortgage lender before you start looking for homes. A preapproval is an estimate of how much a lender will let you borrow to buy a home. It keeps you from wasting time shopping for homes outside your budget, and in some hot seller’s markets, a real estate agent may not meet with you until you have a preapproval letter.

You can use our home affordability calculator to estimate what you can afford as you begin thinking about buying a home – but you’ll get a ballpark figure that isn’t verified. With a mortgage preapproval, a lender verifies your financial information and issues a preapproval letter. The letter signals to sellers and agents that you’re conditionally approved for a mortgage pending the home’s appraisal.

Rocket Mortgage offers Verified Approval.¹ Underwriters confirm a borrower’s income and assets and pull their credit, giving borrowers confidence that they’ll qualify for the home they want to buy.

2. Shop For Your Home And Make An Offer

Connect with a real estate agent to start touring homes. Your real estate agent can schedule viewings and find open houses for you to attend. In certain places, you can also look at homes online using a multiple listing service (MLS).

Your agent will be your eyes and ears for finding the best properties. Real estate professionals can help you find the right home, negotiate a price and make an offer.

3. Get Final Approval

Getting an offer accepted isn’t the final step. There’s more to do to finalize your financing and complete the sale.

If you were preapproved, your lender will verify your credit, income, employment and assets again to make sure you still qualify for the loan. If you weren’t preapproved, your initial approval with happen now. While you order a home inspection to assess the home’s condition, the lender will schedule a home appraisal to confirm the home’s value. Your lender will also hire a title company to check the home's title and confirm there are no issues that would prevent the sale or cause problems later on.

4. Close On Your Loan

Once your loan is approved, you’ll meet with the seller, your lender and your real estate agent to close on the loan and get the keys to the house. You’ll pay your down payment and closing costs and sign your mortgage agreement at closing.

There are many types of home loans. Each has different requirements, interest rate ranges and benefits. The two main categories of mortgages are conforming loans and non-conforming loans. Non-conforming loans include government-backed, jumbo and non-prime mortgages.

Here are some common mortgage types:

Conventional Conforming Loans

A conventional loan is a loan that’s not insured by the federal government. Most conventional loans are conforming loans. “Conventional” means a lender is issuing a loan without a government agency’s guarantee. “Conforming” means the mortgage meets the requirements set by Fannie Mae and Freddie Mac – two government-sponsored enterprises that buy loans to keep mortgage lenders liquid so they have enough capital to continue lending to borrowers.

Conventional loans are a popular choice among buyers. Depending on your finances, homeownership history, and credit score, you may be able to get a conventional loan with a 3% down payment, which can get you into a home sooner. But you should also factor in the monthly cost of private mortgage insurance because you put less than 20% down.

Non-Conforming Loans: Government-Insured Mortgages

Many lenders also offer government-backed mortgages. Government-backed home loans are especially attractive to first-time and low- to moderate-income borrowers and borrowers with smaller savings and credit issues.

FHA Loans

FHA loans are backed by the Federal Housing Administration. They’re popular because they have low down payment and credit score requirements. You can get an FHA loan with a 3.5% down payment and a 580 credit score.

The FHA promises to reimburse lenders when a borrower defaults on their loan, sharing the risk lenders assume when issuing a loan. The guarantee encourages lenders to make these loans available to borrowers with lower credit scores and smaller down payments.

VA Loans

VA loans are backed by the Department of Veterans Affairs. It’s a home buying benefit for qualified active-duty military members, reservists, National Guard members, veterans and their surviving spouses.

VA loans are a great option because, if you qualify, you can buy a home for 0% down, and you won’t pay mortgage insurance.

USDA Loans

USDA loans* are backed by the U.S. Department of Agriculture. The loan only applies to homes in USDA-approved rural and suburban areas. To qualify for a loan, a borrower’s household income can’t exceed 115% of an area’s median income.

You can buy a home for 0% down, and for some borrowers, the USDA’s required guarantee fee will cost less than the FHA mortgage insurance premium.

*Rocket Mortgage doesn’t offer USDA loans at this time.

Conventional Non-Conforming Loans: Jumbo Mortgages

Conforming mortgages are subject to lending limits. In 2024, the conforming loan limit in most of the U.S. is $766,550. In high-cost housing areas, the limit is as high as $1,149,825. If you want to buy a house that costs more than that and need financing, you’ll apply for a jumbo loan.

Because jumbo mortgages exceed conforming loan limits and aren’t backed by government agencies, they’re considered conventional non-conforming loans. A jumbo loan typically requires at least a 20% down payment and tons of paperwork for approval.

Rocket Mortgage offers the Jumbo Smart loan. You can borrow up to $3 million with a Jumbo Smart loan.

Various factors determine your mortgage rate – and some are beyond a lender or borrower’s control.

Two primary factors determine mortgage interest rates: current market rates and the level of risk a lender assumes with the loan. While you can’t control market rates, you can have some measure of control over how a lender views your application. The higher your credit score, the more assured a lender will feel that you can repay the loan with on-time payments.

Like your credit score, you likely have some level of control over your debt-to-income ratio (DTI). The lower your DTI ratio, the more money you’ll have available to make your mortgage payment.

If your financial indicators, like DTI ratio and credit score, demonstrate overall financial health, you’ll likely qualify for a lower interest rate.

Economic Conditions

While the Federal Reserve doesn’t set mortgage rates, market interest rates respond to changes in the federal funds rate.

Your Credit Score, Income And Assets

You can’t control current market rates, but you can have some control over your finances. Pay attention to your DTI ratio and your credit score. The fewer red flags lenders find on your credit report, the more likely it is that you’ll qualify for the lowest possible rates.

To qualify for a mortgage, you must meet certain eligibility requirements. While loan and lender criteria will vary, a borrower typically needs a steady income source, a debt-to-income ratio lower than 50% and a decent credit score (generally at least 580 for FHA or VA loans and 620 for conventional loans).

Most mortgages are either fixed-rate or adjustable-rate mortgages (ARMs).

Fixed-Rate Mortgage

Fixed interest rates stay the same for the entire mortgage term. If you have a 30-year fixed-rate loan with a 6% interest rate, you’ll pay 6% interest until you pay off or refinance your loan. Fixed-rate loans offer predictable payments, which can make budgeting easier.

Adjustable-Rate Mortgage (ARM)

Adjustable mortgage rates adjust based on changes in the market. Most adjustable-rate mortgages have 30-year terms and offer an initial fixed-rate period that usually lasts 5, 7 or 10 years.

After the initial fixed-rate period ends, your interest rate will adjust up or down every 6 months to a year. Your monthly mortgage payment will adjust as the interest rate fluctuates, making the payment more or less expensive.

If you plan to move or refinance before the end of the fixed-rate period or have an expensive mortgage, an adjustable-rate mortgage initially offers lower interest rates than fixed-rate loans.

You may encounter some unfamiliar industry lingo as you shop for a home. Use our glossary to get comfortable with some common mortgage terms.

Amortization

A portion of each monthly mortgage payment goes toward paying interest and paying down a loan’s principal balance. Amortization is how those payments get divided over the life of the loan.

When you begin repaying your loan, a higher portion of your mortgage payment will go toward interest. Over time, more of your payment will go toward paying down your principal balance.

Down Payment

A down payment is the money you pay upfront to purchase a home. In most cases, you’ll put money down to get a mortgage.

The down payment amount you’ll need will vary based on the type of loan you’re getting. Generally, a larger down payment means better loan terms and a smaller monthly mortgage payment. If you put 20% down on a conventional loan, you’ll likely get a favorable interest rate and avoid paying PMI. If you make a 3% down payment – the minimum down payment for conventional loans – you’ll likely pay PMI, increasing your monthly mortgage payment.

Use a mortgage calculator to see how your down payment amount will affect your monthly payments.

Escrow

Part of owning a home is paying for property taxes and homeowners insurance, which lenders manage on a borrower’s behalf through an escrow account. The escrow account operates like a noninterest-bearing checking account and collects the money your lender uses to pay your taxes and insurance. The escrow payments are added to your monthly mortgage payment and then deposited into the escrow account by your lender.

Not all mortgages have an escrow account. If your loan doesn’t have one, you must pay your property taxes and homeowners insurance bills yourself. An escrow account is typically required if your down payment is less than 20%.

How much you have in your escrow account will depend on the annual cost of your insurance and property taxes. Because these expenses may change from year to year, your escrow payment can change, causing your monthly mortgage payment to increase or decrease.

Interest Rate

An interest rate is a percentage charged by a lender each month as a fee for borrowing money. Interest is based on macroeconomic factors, like the federal funds rate, and a borrower’s credit history and financial fitness, like their credit score, income and assets.

Mortgage Note

A mortgage note is a promissory note that details the repayment terms of a loan used to purchase a property. It’s like an IOU, and it details the repayment guidelines, including:

• Interest rate
• Interest rate type (adjustable or fixed)
• Total loan amount
• Loan term (length of time to pay back the loan)

Once the loan is repaid, the homeowner receives the promissory note.

Loan Servicer

A loan servicer sends monthly mortgage statements, processes payments, manages escrow accounts and responds to borrower inquiries.

Sometimes, the servicer is the same company that approved a borrower’s mortgage loan – but not always. Lenders may sell the servicing rights of your loan, and you may not get to choose your new servicer.

Becoming a homeowner requires money, time and effort – and for motivated home buyers, it’s worth the effort. Take the time to familiarize yourself with every aspect of a mortgage before deciding on one of the biggest financial investments you may ever make. Ready to take the first step in your home buying journey? Start the mortgage approval process today! You can also give us a call at (833) 326-6018.

¹ Participation in the Verified Approval program is based on an underwriter’s comprehensive analysis of your credit, income, employment status, assets and debt. If new information materially changes the underwriting decision resulting in a denial of your credit request, if the loan fails to close for a reason outside of Rocket Mortgage’s control, including, but not limited to satisfactory insurance, appraisal and title report/search, or if you no longer want to proceed with the loan, your participation in the program will be discontinued. If your eligibility in the program does not change and your mortgage loan does not close due to a Rocket Mortgage error, you will receive the $1,000. This offer does not apply to new purchase loans submitted to Rocket Mortgage through a mortgage broker. This offer is not valid for self-employed clients. Rocket Mortgage reserves the right to cancel this offer at any time. Acceptance of this offer constitutes the acceptance of these terms and conditions, which are subject to change at the sole discretion of Rocket Mortgage. Additional conditions or exclusions may apply.