What is a mortgage? Loan basics for beginners

What is a mortgage?

What does mortgage mean? A mortgage is a legal agreement, also referred to as a promissory note, between two parties. The borrower, or mortgagee, signs the promissory note to use the money provided by the lender, or mortgagor, to purchase a specific property.

The promissory note outlines the responsibilities of the borrower and the lender. The borrower promises to make regular payments to the lender. Those payments are applied to the principal amount borrowed, plus interest and any fees.

Until the loan is paid off, the property is held as collateral. The lender can foreclose on your mortgage, meaning it can take ownership of the home. In most foreclosures, the lender would then sell the home to recoup its losses.

Who are the parties in a mortgage?

Several parties may be involved in a mortgage transaction, including the borrower, lender, and co-signer.

Mortgage lender

A mortgage lender provides the borrower with the money they need to buy a property. The lender typically is a financial institution, like a bank or credit union. It also can be an online company, like Rocket Mortgage®.

Lenders will review the borrower’s finances, including their credit history, credit score, debt-to-income ratio, and any other assets they may have, to confirm the borrower can afford to repay the loan.

Borrower

The borrower signs the promissory note on a mortgage to borrow money for buying a home. The borrower can be an individual, a couple, or a group of people.

Co-Signer

A co-signer agrees to take responsibility for repaying the mortgage if the primary borrower cannot. A co-signer would need to make any missed payments, even if their name is not on the house title. A co-signer is typically required if the borrower has a limited or low credit history.

The most common types of mortgages

There are many choices to make when choosing a mortgage.

What is a fixed-rate mortgage?

The interest rate on a fixed-rate mortgage never changes. That ensures that your monthly payment for your loan’s principal and interest remains the same for the entire loan term.

What is an adjustable-rate mortgage?

The interest rate on an adjustable-rate mortgage changes, usually once a year. ARMs typically have an introductory fixed rate that is lower than the rate for a fixed-rate loan and expires after a specific number of years. After that, the interest rate will adjust according to market rates, and your payment for principal and interest may increase or decrease along with the rate. You’ll see ARMs described as 5/1 or 7/1. The first number is how many years you pay the introductory rate, and the second number is how often the rate adjusts after that. A 7/1 ARM would have a fixed rate for 7 years and then adjust every year after that.

Conventional conforming loans

Conventional conforming loans are private loans that meet specific government requirements, primarily a maximum loan amount. The conforming loan limit depends on how many units are in the home you’re buying, and whether it’s located in a high-cost county. Homes in designated high-cost counties have a higher conforming loan limit. If your down payment is less than 20%, your lender will require you to pay for private mortgage insurance. Lenders can sell conforming loans to Fannie Mae or Freddie Mac, allowing them to recover the loan amount and make additional loans. If you put less than 20% down for your loan, you may need to pay private mortgage insurance.

Conventional nonconforming loans

Nonconforming loans are mortgages offered by private lenders that don’t meet the conforming loan standard in some way. The most common nonconforming loan is a jumbo loan, so called because it exceeds the conforming loan limit. The 2026 limit for a one-unit home is $832,750, and $1,249,125 in specific high-cost areas. To borrow more than that, jumbo loan lenders usually require more documentation, a more robust credit history, and a minimum down payment of 20%.

What is an FHA mortgage?

Federal Housing Administration loans are for low- to mid-income buyers and allow borrowers to have a lower credit score. FHA loans require a minimum down payment of 3.5% with a credit score of at least 580. Some lenders provide FHA loans to borrowers with a credit score between 500 and 579 with a 10% down payment. Rocket Mortgage requires a credit score of at least 580 and a minimum down payment of 3.5%

What is a VA mortgage loan?

Veterans Affairs loans are available only to military personnel, veterans, and their surviving spouses. VA loans don’t require a down payment, but borrowers may need to pay a one-time funding fee and meet additional requirements.

What is a USDA loan?

U.S. Department of Agriculture loans are for low- to mid-income borrowers buying a home in a specific rural area. Household income must generally be at or below 115% of the area median income. Those who qualify may not need a down payment.

What’s the best type of mortgage for you?

The best type of mortgage for you is based on factors such as:

• The home’s purchase price. If you want to qualify for government-backed or conventional loans, the home’s price needs to be at or below the maximum threshold. Otherwise, you may need a jumbo loan.
• How much can you put down? Some conventional loans require a down payment of only 3%. Government-backed loans like VA loans may not need one. When speaking to a lender, be up front about the amount you can put down and see what your options are.
• Whether you want a fixed or adjustable rate. Many lenders prefer the predictability of a fixed-rate loan, especially if you plan to own the home for a long time, while an ARM may make sense if you plan to sell or refinance before your rate adjusts.
• Lender fees and interest rates. Your mortgage rate directly affects how much your monthly payment will be. What is a good interest rate for a mortgage? That depends. What’s probably more important to know is that even a small reduction in your interest rate can save you a lot of money. You also will need to pay fees such as closing costs, which typically total 3% – 6% of your loan amount. Be sure to look at a loan’s annual percentage rate, too. The APR includes all the costs of a loan and allows you to directly compare mortgage offers.
• The loan repayment term. A 30-year mortgage is the most common, followed by a 15-year loan. Ask your lender if you’re interested in a custom term.
• If you meet the requirements for government-backed loans. FHA, VA, and USDA loans can make buying a home more affordable for eligible borrowers. It’s worth checking if you’re eligible.

How to get a mortgage

Most lenders will follow the steps outlined here to assess your eligibility and approve you for a mortgage.

Prepare your finances

You’ll want to review your finances to understand how much you can afford to spend on a home. Rocket Mortgage has an affordability calculator that can help you get started. Important figures to check include your credit score and your DTI ratio. Lenders use those numbers to gauge how well you manage your finances and whether you can afford the monthly mortgage payment. You can use a mortgage calculator to estimate costs. You also will need to have money saved up for the down payment. You also have to pay closing costs, which typically total 3% - 6% of your loan amount.

Get mortgage preapproval

When you’re ready to start shopping for a home, apply for mortgage preapproval. The lender will review the financial information you submit and estimate how much it expects you could borrow to buy a home. This is useful because it shows real estate agents and sellers that you’re ready to buy. Mortgage preapproval letters are usually valid for 60 – 90 days.

Shop for a home and make an offer

Work with a real estate agent to find and tour available homes in your desired area. Your agent can help you submit a competitive offer to sellers. The purchase offer will include the price you’re offering, important terms such as contingencies that need to be met for the sale to go through, any offer of earnest money, and a timeline for closing the sale.

Get final approval

Once the seller accepts your offer, you officially apply for a mortgage. Your lender will provide you with a Loan Estimate for your loan costs. While your lender is underwriting the loan, the lender will order an appraisal of the property to ensure it’s worth enough to justify the loan. This is when the contingencies come into play and must be met for the sale to proceed. A home inspection contingency is common and requires the home’s condition to be examined and reviewed by a third-party professional.

Close on your loan

Your lender will provide you with a Closing Disclosure at least three days before your scheduled closing. This document finalizes all the terms and costs associated with your mortgage and the transaction. You’ll see projected monthly payments, fees, interest rates, and other loan terms. At closing, you’ll pay closing costs and the down payment, and then sign the documents that fund your loan and transfer legal ownership of the property to you.

Mortgage glossary

Here are some standard terms and concepts related to getting a mortgage.

Amortization

Amortization is a method for calculating the payment on a loan so that the interest and principal are paid off over a specific time. It also determines how much of each payment goes to principal and how much to interest. When you start paying your mortgage, most of your payment will go to interest. Over time, that amount will decrease, and more of each payment will go toward reducing the principal until the entire loan is paid off. To better understand how this works, check out this amortization calculator from Rocket Mortgage.

Down payment

Most mortgages require the borrower to pay part of the cost of the home up front. This is the down payment, which is usually expressed as a percentage of the purchase price. The mortgage provides the rest of the money needed to purchase a home. How much of a down payment you need depends on the home’s purchase price, the type of loan you’re using to buy the home with, and your lender. This down payment calculator from Rocket Mortgage can help you estimate costs.

Escrow

Escrow is a contractual arrangement where a third party collects, holds, and pays out funds related to a transaction. When you buy a home, an escrow account will be set up for all expenses. You’ll pay in your down payment and closing costs, and an escrow agent will ensure the correct parties are paid for their services. The account also will collect your mortgage funds and pay out any profit to the seller.

Many lenders set up an escrow account to ensure borrowers pay their homeowners insurance premiums and property taxes. The lender will estimate the annual cost and add a prorated amount to your monthly mortgage payment. That amount is kept in the escrow account and then pays your insurance premiums and property taxes on your behalf.

Interest rate

The interest rate determines how much you pay the lender to borrow the principal. The interest rate is a percentage. The interest rate is different from the APR, which includes the interest rate and all the fees and costs associated with the loan.

Mortgage note

A mortgage note also is known as a promissory note. This legal document outlines each party’s responsibilities and the terms for a mortgage.

Loan servicer

A loan servicer is responsible for managing a mortgage. The servicer collects your monthly payment and manages your escrow account. Lenders often sell the mortgages they issue to a loan servicer, so this can be a different company than your original lender.

The bottom line: Mortgages make homeownership possible

Mortgages allow borrowers to finance the purchase of a home over a long period of time. In doing so, mortgages make it possible for more people to own a home and build equity. If you’re just learning about the home buying process, it’s important to understand how mortgages work and what your options are.

If you’re ready to explore your borrowing options, start the approval process today with Rocket Mortgage.