What is a Mortgage?

Most people dream of the day when they can finally purchase a home, after years of saving and searching for the perfect property. However, many people cannot afford to pay the entire price of a house with the savings they’ve accumulated. That’s where mortgages come in!

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A mortgage is an agreement between a lender and a borrower that allows you borrow money to purchase a property. The most common types of mortgages have a thirty-year duration, but there are some mortgages with other durations. Additionally, there are special mortgages for veterans and first-time homebuyers, among many others.

Let’s start with the most important part of a mortgage — the interest rate. For a quick refresher, interest rates are fees charged by lenders to borrow money. Mortgages generally have lower interest rates than personal loans and credit cards because they’re secured by a physical asset, which is the house. Depending on your credit score, you can qualify for lower interest rates too!

For example, you get a mortgage for a house that cost $250,000 at a 5% interest rate. Over the thirty years you finance the house, you will end up paying back the initial $250,000 borrowed PLUS $233,000 in overall interest payments. Additionally, your monthly payment would be around $1,342. Conversely, at a 3% interest rate, you would only pay back the $250,000 borrowed plus $130,000 in overall interest payments. Do you see the importance of having the highest possible credit score to get the lowest possible interest rate?

As previously mentioned, you can get mortgages for different durations. Fifteen-year mortgage terms are also very common. Financing a house for fifteen years instead of thirty years will typically result in higher monthly payments but lower overall interest paid.

For example, you get a mortgage for a house that costs $250,000 at a 5% interest rate. Over the fifteen years you finance the house, you will end up paying back the initial $250,000 borrowed PLUS $105,000 in overall interest payments. That is a lot less than the $233,000 paid at a 5% interest rate in the thirty-year mortgage example! Also, your monthly payment would be around $1,976 — much higher than the $1,342.

When deciding between a thirty- or fifteen-year mortgage, it’s important to consider your financial position and how long you plan to live in the house you’re buying. If you can afford the higher monthly payments and plan to be in your house for a long period of time, it may make sense to get a fifteen-year mortgage as it will help you pay off your house faster and pay less in interest!

Another component of mortgages is the down payment, which is the amount of money you must pay up front to get a mortgage. Most lenders require a 20% down payment on a house. So, if you’re purchasing a house for $250,000, you would have put up $50,000 of your own money. That may seem like a lot but saving small percentages of your monthly income can bring you closer to your down payment goal.

There are certain mortgage programs that can assist veterans and first-time homebuyers. These mortgages require lower down payments but may require additional mortgage insurance payments. For more information on these programs, check with your prospective lender.

Mortgages are powerful tools in building wealth and owning property. By putting up a small amount of money and paying small amounts of money each month, you own a property. Remember, it is important to have the highest possible credit score to get the best terms on a mortgage. You can read more about credit scores by reading this article (link to credit score article).