A mortgage is a loan specifically used to purchase real estate, with the property itself serving as collateral. If the borrower fails to repay, the lender can foreclose on the property. The two dominant mortgage structures are the fixed-rate mortgage and the adjustable-rate mortgage, or ARM. A fixed-rate mortgage has the same interest rate for the entire loan term, resulting in identical monthly payments and offering predictability; common terms are 15, 20, or 30 years. An ARM has an interest rate that changes periodically based on a benchmark index plus a fixed margin, typically expressed as ARM rate = index + margin. Initial ARM rates are usually lower than fixed rates, but payments can rise significantly when the loan resets.
ARMs include rate caps to limit how much the rate can change. There are three typical caps: an initial cap on the first adjustment, a periodic cap on each subsequent adjustment (often 1 to 2%), and a lifetime cap that sets the maximum total increase over the loan's life. These protections help prevent payment shock, the sudden, often large increase in monthly payment that occurs when an ARM resets. Common references for the index include SOFR (the Secured Overnight Financing Rate), which replaced LIBOR as the primary US dollar benchmark because LIBOR was phased out over manipulation and liquidity concerns. The prime rate, published in The Wall Street Journal based on a survey of major banks, is another widely used benchmark, especially for home equity lines of credit and credit cards.
The monthly housing payment is usually summarized as PITI, which stands for Principal, Interest, Taxes, and Insurance. Lenders use PITI when calculating debt-to-income ratios to qualify borrowers, and homeowners should budget for the full PITI rather than just the loan payment. Property taxes and homeowners insurance are commonly collected through an escrow account, a separate account the lender manages, paying these bills on the borrower's behalf as they come due. Private mortgage insurance, or PMI, protects the lender if the borrower defaults and is generally required when the down payment is less than 20% of the home's value. PMI must be cancelled automatically once loan-to-value reaches 78% based on the original amortization schedule, and borrowers can request cancellation at 80% loan-to-value provided the home value has not declined and payment history is current.
Several specialized mortgage programs exist to expand access to homeownership. FHA loans are mortgages insured by the Federal Housing Administration, designed for borrowers with lower credit scores or smaller down payments; they allow down payments as low as 3.5% but require both an upfront and ongoing mortgage insurance premium, or MIP. VA loans are guaranteed by the U.S. Department of Veterans Affairs for eligible service members, veterans, and their families, and their key benefit is requiring no down payment and no private mortgage insurance, often with competitive rates; a one-time VA funding fee (about 1.25% to 3.3% of the loan) sustains the program and can be rolled into the loan or waived for disabled veterans. USDA loans serve low-to-moderate-income buyers in eligible rural areas with 0% down payment and reduced mortgage insurance costs. Jumbo loans exceed the conforming loan limits set annually by the Federal Housing Finance Agency (a figure in the high six figures for most US areas, reset every year and higher in designated high-cost counties), cannot be purchased by Fannie Mae or Freddie Mac, and carry stricter underwriting and slightly higher rates. Several mortgage types, including FHA, VA, and USDA loans, are assumable, meaning a buyer can take over the seller's existing loan terms, which becomes especially valuable when current market rates are higher than the assumed rate.