A mortgage is simply a loan used to purchase real estate, where the property itself serves as collateral. Let's break down all the key terms and concepts you need to understand.
What Is a Mortgage?
When you get a mortgage, you're borrowing money from a lender (usually a bank) to buy a home. You agree to pay back the loan plus interest over a set period, typically 15 or 30 years. If you fail to make payments, the lender can foreclose and take the property—that's what makes it a "secured" loan.
Quick Example
Key Mortgage Terms Explained
Principal
The principal is the amount you actually borrow—the loan amount. In our example above, it's $320,000. Each monthly payment includes a portion that goes toward paying down this principal balance. As you pay off principal, you build equity in your home.
Example: If your $320,000 loan includes a $600 principal payment this month, your new loan balance becomes $319,400.
Interest
Interest is what you pay the lender for borrowing their money—it's their profit. Interest is calculated as a percentage of your remaining loan balance (the interest rate). The rate is typically expressed as an annual percentage, but it's applied monthly.
Example: With a 6.5% annual interest rate on a $320,000 loan:
- • Monthly rate: 6.5% ÷ 12 = 0.542%
- • First month interest: $320,000 × 0.00542 = $1,733
- • This amount decreases each month as you pay down principal
Amortization
Amortization is the process of paying off your loan over time through regular payments. An amortization schedule shows how each payment is split between principal and interest, and how your loan balance decreases over the life of the loan.
Front-Loaded Interest
Example payment breakdown on a $320,000 loan at 6.5%:
First Payment:
Interest: $1,733
Principal: $290
Payment #180 (Year 15):
Interest: $1,150
Principal: $873
Fixed-Rate vs. Adjustable-Rate Mortgages
Fixed-Rate Mortgage (FRM)
The interest rate never changes for the entire loan term. Your principal and interest payment stays the same every month (though taxes and insurance may change).
Adjustable-Rate Mortgage (ARM)
The interest rate is fixed for an initial period (e.g., 5, 7, or 10 years), then adjusts periodically based on market conditions. Common types: 5/1 ARM, 7/1 ARM, 10/1 ARM.
PITI: Your Total Monthly Payment
PITI stands for Principal, Interest, Taxes, and Insurance—the four components of your total monthly housing payment:
Principal
The portion paying down your loan balance
Interest
The cost of borrowing money from the lender
Taxes
Property taxes paid to your local government (usually via escrow)
Insurance
Homeowners insurance (and PMI if down payment is less than 20%)
Example PITI Breakdown ($400k home, $320k loan, 6.5% rate):
Escrow
An escrow account is a separate account held by your lender or mortgage servicer. Each month, a portion of your payment goes into escrow to cover property taxes and homeowners insurance when they come due. The lender pays these bills on your behalf.
Loan Terms Explained
30-Year Mortgage
The most common loan term in the U.S. Your loan is paid off over 360 monthly payments.
15-Year Mortgage
Paid off in half the time with 180 monthly payments. Usually comes with a lower interest rate.
Comparison on $320,000 loan:
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What's Next?
Now that you understand the basics, you're ready to explore different types of mortgages, understand what affects interest rates, and calculate how much house you can afford. Knowledge is power when it comes to making one of the biggest financial decisions of your life.
Put Your Knowledge to Use
Now that you understand mortgage basics, use our calculator to see how these concepts apply to your specific situation.
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