A mortgage is a loan used to purchase property, secured by the property itself. The principal is the amount borrowed, while mortgage interest is the cost of borrowing, expressed as a rate. Over time, the loan is repaid through amortization—scheduled payments that gradually reduce both principal and interest. The total monthly housing cost is often summarized as PITI, which stands for principal, interest, taxes, and insurance. Mortgages come in many forms. A fixed-rate mortgage maintains the same interest rate for the entire term, while an adjustable-rate mortgage (ARM) has a rate that changes periodically based on market conditions. Term length also varies: a 30-year mortgage is the most common in the U.S., while a 15-year mortgage requires higher monthly payments but results in much less total interest. A balloon mortgage features small payments during the term, with a large balance due at the end.
Lenders evaluate borrowers using several ratios. The debt-to-income ratio (DTI) compares monthly debt payments to gross monthly income, with lenders typically preferring a DTI below \(43\%\) and \(36\%\) or lower considered ideal. The loan-to-value ratio (LTV) expresses the mortgage amount as a percentage of the property's value. The down payment—the upfront cash payment toward the purchase—affects LTV and the need for private mortgage insurance (PMI), which protects the lender when the down payment is less than \(20\%\). PMI is distinct from homeowner's insurance, which protects the homeowner against property damage and liability. Lenders also distinguish between prequalification, an informal estimate of borrowing capacity, and preapproval, a more rigorous preliminary commitment based on a financial review.
Several government-backed and specialized loan programs exist. An FHA loan allows lower down payments (often \(3.5\%\)), a VA loan serves U.S. veterans with no down payment requirement, and a USDA loan supports rural home buyers with no down payment for eligible borrowers. A jumbo loan exceeds conforming loan limits, while a conforming loan meets the standards of Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corporation), two government-sponsored enterprises that purchase mortgages. Lenders sell these loans on the secondary mortgage market, where they are pooled into mortgage-backed securities through mortgage securitization, providing lenders with fresh capital to originate new loans.
Borrowers may also refinance an existing mortgage to obtain better terms, withdraw equity, or both. A cash-out refinance replaces the existing loan with a larger one, allowing the borrower to take the difference in cash. A home equity line of credit (HELOC) is a revolving credit line secured by home equity—the portion of the home owned outright, equal to value minus outstanding debt. When a borrower cannot make payments, the lender may initiate foreclosure, the legal process by which the lender repossesses the property. Alternatives include a short sale, in which the property is sold for less than the mortgage owed with lender approval, leaving the property as real estate owned (REO), or bank-owned, after foreclosure.