Real Estate Terms

Mortgage Definition

Home buying can be stressful, and since it’s a significant investment, home buyers mostly need loans to make purchases. Mortgages provide a perfect option for purchasing homes. They allow the borrower to make monthly payments if someone doesn’t have enough lump sum to buy a home. In this post, I’ll explain how mortgages work in real estate and what you must know about them if you’re preparing for a real estate exam.

What Is a Mortgage in Real Estate?

A mortgage is a loan agreement between the lender and the borrower to buy a home. This is a type of secured loan where the home is the collateral. It is a long-term debt that the borrowers can obtain from any financial institution for a term of 15, 20, or 30 years. If the borrower defaults on the loan, they lose their home, and the ownership of the home is transferred to the lender through foreclosure. The lender can sell the home or keep it to recover from the loss.

During the loan term, the borrower pays interest and a principal amount in monthly payments. As the borrower makes timely payments, the outstanding balance reduces until the mortgage reaches maturity. The lender uses this amount to cover the amount he gave the buyer to purchase the home. To understand mortgages better, I’ve explained the main terms below:

Mortgage Lenders

A mortgage lender is a bank, credit union, or any financial institution that provides loans for purchasing homes. Mortgage lenders are different from brokers. Brokers work as intermediaries between mortgage lenders and home buyers. At the same time, mortgage lenders offer home loans. They set loan terms, interest rates, monthly payments, and other guidelines necessary for providing a loan and obtaining payments. Brokers don’t set guidelines, but they are licensed professionals who receive the buyer’s mortgage application and help them find suitable lenders. The following are the different types of mortgage lenders:


To get the best rates and terms, a home buyer must choose a reputable bank that offers affordable mortgages. The top picks for banks that provide mortgages are Bank of America, PNC Bank, Chase, Rocket Mortgage, and Ally Bank. Applying these perks has many advantages; for instance, you can enjoy discounts and other features. But since these mortgage lenders receive lots of applications, there is a chance that the borrower will have to face longer closing times and higher interest rates.

Credit Unions

Credit unions operate differently from banks. These financial institutions generate revenue for investors and are non-profit institutions operated by members. Credit unions are a good option as they offer lower interest rates than banks. Besides that, credit unions have low fees and provide better service and personalization. Some renowned credit unions include Bethpage, Alliant, Penfed, and State Employees Credit Union. However, one disadvantage is that credit unions offer a limited number of loans.


Direct lenders or non-bank lenders use their funds to provide loans for purchasing homes. Direct lenders offer flexible eligibility criteria and allow borrowers to obtain more complex loans. Non-bank lenders have limited options, and they mostly offer their products. Thus, the borrower might need to apply to multiple direct lenders to check the best option.

The Mortgage Process

Mortgage works like other loans, a lender provides a mortgage to the buyer or a set amount of loan term. The mortgage is secured by collateral which is the home, and if the buyer defaults on the loan, the lender can foreclose it. The lender puts a lien on the property during the mortgage, and when the mortgage is paid off, title is transferred to the buyer. The following are a few important terms related to mortgages:

Loan Amount

This is the amount that the borrower gets from a lender to purchase the property. The loan amount can be between 75% to 95% of the property’s total purchase price. The borrower will repay this amount in the form of monthly payments. These monthly payments will include interest and principal.

Down Payment

The buyer has to pay an amount which is an initial upfront payment to the lender. This is the sum of money that the lender takes and subtracts from the loan amount. The higher the down payment, the lesser the amount of outstanding mortgage.

Loan Term

The loan term is the mortgage duration during which the home buyer repays the outstanding amount. Mortgages are usually long-term, for 15, 20, or 30 years. During this period, the lender holds a lien on the property.


Amortization means the gradual repayment of loans over time. The payments include interest and principal. In most cases, mortgages are fully amortized till the end of the loan. This means that most loans will be paid off till the end of the loan, and ownership of the property will be transferred to the borrower.

Interest Rate

The interest rate is the buyer’s cost to the lender. Most mortgages have interest rates ranging between 3% and 8%. Buyers can get better rates if their credit scores are good. For instance, buyers with a credit score of more than 740 will get lower interest rates for purchasing homes.

Types of Mortgages

Mortgages come in different forms according to interest rates and terms. Some mortgages are short-term, while others are long-term. Besides that, there are adjustable-rate and fixed-rate mortgages. Apart from that, there are government-backed loans and balloon loans. The following is a quick overview of the various types of mortgages:

Fixed-Rate Mortgages

Fixed-rate mortgages are those mortgages in which the interest rate is fixed and remains the same throughout the loan term. Similarly, the borrower’s monthly payments towards the mortgage also stay the same. The interest rate is determined before the loan is closed, and the loan term usually lasts for 30 years. Longer terms mean lower monthly payments but higher overall costs. These loans are also called traditional mortgages and are a good option if the borrower has a stable monthly income.

Adjustable-Rate Mortgages

Adjustable-rate mortgages are those mortgages in which the interest rate increases or decreases as the market rates change. Initially, the interest rate is fixed, and then it changes according to the current interest rates. These loans are a good idea if the borrower wants a low initial rate compared to fixed-rate mortgages. This makes mortgages cheaper for the short term, but if the rate increases, it can get costly.

Government-Backed Loans

Government-backed loans are those loans that government institutions guarantee. For instance, the FHA, VA, and USDA loans. The Federal Housing Administration guarantees that FHA loans are good for first-time home buyers. The VA loans are offered by the Department of Veteran Affairs and are offered to veterans, service members, and their family members. The USDA loans are backed by the U.S. Department of Agriculture and are created for low or moderate-income home buyers.

Reverse Mortgage

Reverse mortgages are created for home buyers aged 62 or more who want to earn income according to their share in the home equity. These loans are suitable for those people who need cash, either as a lump sum, line of credit, or fixed monthly payments. This is a different type of loan where the lender gives monthly payments to the borrower over time, and the loan balance accumulates over time. This loan is due when the borrower sells the home, moves away permanently, or when the borrower dies.

Balloon Mortgage

Balloon mortgages start with low initial payments that involve interest-only payments and then grow slowly till the end of the term. These loans are short-term, normally for five to seven years. Balloon mortgages don’t fully amortize until the end of the term, and the borrower must pay the remaining balance when the loan matures. A balloon payment is paid as a lump sum to the lender to pay off the loan.

Mortgage Examples

Example 1: Suppose person-A approaches a lender to purchase a home. The home costs $315,000, and the lender requires a 10% down payment. The mortgage has the following details:

  • Home price: $315,000
  • Down payment: $31,500 at 10%
  • Loan amount: $283,500
  • Interest rate: 6.7%
  • Loan term: 30 years
  • Monthly payment with PMI: $2,230.82

With this mortgage, person-A pays $31,500 down as upfront fees. The remaining loan amount has to be paid over 20 years in monthly payments. The monthly payments will be $2,230.82, which includes interest and principal. At the end of the term, the lender will transfer the property ownership to the borrower.

Example 2: Person B wants to buy a home, but she doesn’t have enough cash at hand to pay as a down payment for the mortgage. Besides that, her credit score isn’t good enough; her score is 600, which makes it challenging to qualify for a mortgage from a private lender. A loan officer recommends she get an FHA mortgage as they require lower down payments than other mortgages. With an FHA loan, person B can get a mortgage with a 3.5% down payment requirement. She obtains the FHA mortgage as follows:

  • Home Price: $220,000
  • Down payment: 3.5% ($7,700)
  • Loan Term: 30 years
  • Interest rate: 7.23%
  • Loan Amount: $216,150

This government-backed FHA loan was helpful for person B as she had to pay only $7,700 as a down payment.

Frequently Asked Questions

What Documents are Required to Obtain a Mortgage?

The lender requires a few documents to provide a mortgage to the home buyer. The documents include: 

  • Social security card
  • Credit History
  • Bank statements 
  • Assets and debts
  • At least one month of pay stubs
  • Rental history
  • Loan commitment 

The lender may require additional documentation such as updated bank statements, employment verification, and more. These are the main requirements for employed people; for self-employed people, the mortgage requirements are different. The following are the documents needed for self-employed borrowers:

  • Social security card
  • Credit History
  • Bank Statements
  • Business License
  • Self-employed income
  • Two years of personal income tax returns
  • Two years of business income tax returns
  • Year-to-date profit and loss statement (P&L)
  • Balance sheet

Does the Buyer Have to Make a 20% Down Payment?

No, not all lenders require a 20% down payment. The down payment can be as low as 3.5% or even zero for some mortgages. However, more down payment means the buyer will have to pay a lower outstanding mortgage. If the buyer pays down a lower initial cost, the outstanding mortgage will be more, which the buyer has to pay during the term.

Does the Interest Rate Change in Mortgage?

Interest rates are fixed or adjustable depending on the type of mortgage. For instance, FHA mortgages mainly offer fixed interest rates, which means the rate will not change during the term. With an adjustable-rate mortgage, the interest rate will go up or down. ARMs are more complex than FRMs, and the payments are also difficult to manage. However, FRMs are more challenging to qualify for.

What to Know for the Real Estate Exam

Mortgages are loan agreements that allow home buyers to obtain funds to purchase properties. Financial institutions provide these home loans to help people who want to buy homes. Some of these mortgages are government-backed, while others are not. The government-backed loans come with a guarantee by the government that protects the lenders in case the borrower defaults. Mortgage payments are called PMI, including principal, interest, and property taxes. The home buyers must pay monthly payments as PMI during the loan term until the loan fully matures and the outstanding balance is zero. This way, in the end, the buyer receives the ownership of the property. Go through our Real Estate Vocabulary to learn more terms that will be helpful for your real estate exam. 

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