How does a mortgage work?

A mortgage is a loan to buy a home, repaid in equal monthly payments over a set term, usually 15 or 30 years, with the home as collateral. Early payments go mostly to interest, and the share that pays down the loan grows every month.

Payments are fixed, the split is not

On a fixed-rate loan, principal and interest stay the same every month. Because interest is charged on a shrinking balance, more of each payment goes to principal over time. This is called amortization.

The term changes the total cost

At the same 6.5% rate, a $270,000 loan costs $344,370 in interest over 30 years and $153,358 over 15 years. The 15-year payment is higher: $2,352 versus $1,707.

Fixed versus adjustable

A fixed rate never changes. An adjustable-rate mortgage (ARM) often starts lower, then the rate and payment can rise, sometimes by hundreds of dollars a month.

Mortgage insurance can come off

On a conventional loan with less than 20% down, you can ask to cancel PMI when the balance is scheduled to reach 80% of the home's original value. It must end automatically at 78% if you are current.

What a mortgage payment covers

The core of the payment is principal, the part that pays back what you borrowed, and interest, the cost of borrowing. Many lenders also collect property tax and homeowners insurance each month and hold it in an escrow account, then pay those bills when they are due. If you put less than 20% down on a conventional loan, mortgage insurance is usually added too.

So a payment quote of principal and interest alone can be hundreds of dollars short of what leaves your account each month.

Why early payments are mostly interest

Each month, the lender charges interest on the balance you still owe: the balance times the yearly rate divided by 12. The rest of your fixed payment pays down principal.

At the start, the balance is at its largest, so interest takes most of the payment. As the balance falls, interest shrinks and principal grows. On a $270,000 loan at 6.5%, principal is $244 in month 1, about $464 by the end of year 10 and about $888 by the end of year 20.

Loan terms and rate types

The term is how long you have to repay. Thirty years is common because it keeps the payment lower. Fifteen years costs more each month but much less in total interest, and the rate offered is often lower too.

A fixed-rate mortgage keeps the same principal and interest payment for the whole loan. An adjustable-rate mortgage changes rate after a set period. The CFPB warns that many ARM borrowers underestimate how much their rate can rise, so know your maximum possible payment before you choose one.

Common types of home loans

Conventional loans are not backed by the government. Some offer down payments as low as 3%, and they usually need private mortgage insurance below 20% down. FHA loans, insured by the Federal Housing Administration, allow 3.5% down. VA loans offer zero down for eligible veterans and service members, and USDA loans offer zero down for eligible buyers in rural areas.

Lower down payment loans usually cost more over time through mortgage insurance or a higher rate. Compare the total cost, not just the cash you need today.

Getting and comparing offers

After you apply, each lender must send a Loan Estimate within three business days. It shows the rate, the monthly payment, closing costs and features like a prepayment penalty. Ask for estimates from at least three lenders and compare them side by side.

Points are fees you can pay at closing to lower your rate; one point is 1% of the loan. They make sense only if you will keep the loan long enough for the lower payment to repay what you paid up front. Three business days before closing, you get a Closing Disclosure with the final terms.