A loan provided by a lender – usually a bank, mortgage company, or other financial institution – to purchase a residence
Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets.
A home mortgage is a loan provided by a lender – usually a bank, mortgage company, or other financial institution – to purchase a residence. The home mortgage agreement requires the borrower to transfer the title of the property to the lender, with a condition to transfer back the title when the borrower makes the final mortgage payment and complies with other terms of the mortgage agreement.
The property purchased acts as collateral for the loan, and the lender can take possession and dispose of the property to recover any losses incurred if the borrower defaults on loan repayment or fails to comply with other terms of the mortgage agreement.
Generally, home mortgages range from 10 to 30 years, and the borrower is required to make a predetermined series of mortgage repayments during the agreed period of the loan.
A home mortgage refers to a loan given by a financial institution for the purchase of a residential property.
It can either be a fixed-rate mortgage or an adjustable-rate mortgage, ranging between 5 and 30 years, or longer.
The borrower transfers the title of the residential property to the lender, on the condition that the latter will transfer back the title upon completion of the mortgage payments, and in compliance with all terms of the mortgage agreement.
How Home Mortgage Works
Mortgage lending is used as the primary method of financing private ownership of residential property in most countries around the world. Home mortgages allow individuals to own a property and pay a predetermined series of payments over an agreed period.
Mortgage payments comprise various fees, including principal, interest, a portion of property taxes, private mortgage insurance, and other fees. Home mortgages are customized to meet the needs of the borrower and the lender.
When applying for a home mortgage, the borrower is required to submit an application to the lender, detailing their financial history. The lender wants the assurance that the potential borrower can meet the financial obligations arising from the loan.
Sometimes, borrowers may use mortgage brokers to help them find the best mortgage rates in the market at a commission. Once the lender and the borrower agree on the terms of the mortgage loan, a lien is attached to the property.
The lien is recorded in public records, and it gives the lender the ability to take possession of the property if the borrower defaults on the loan obligations. A home mortgage may carry a fixed interest rate, an adjustable interest rate, or a combination of both.
Types of Home Mortgages
Home mortgages come in various forms, with some mortgages lasting for five years, while others last for 30 years and even longer. Stretching the repayment period reduces the monthly payments that borrowers are required to pay over time.
Here are the two main types of mortgages:
1. Fixed-Rate Mortgage
Fixed-rate home mortgages require borrowers to pay the same interest rate for the entire life of the loan. This means that the total for the principal and interest payments remain fixed from the first mortgage payment to the final payment.
For example, if a borrower takes a 30-year home mortgage with a fixed-rate interest of 4%, the borrower will pay the 4% interest until they pay off the loan.
The monthly payments do not change even with an increase in market interest rates. The fixed monthly payments make it easier to budget the repayments. However, if the interest rate declines, the borrower can refinance the mortgage to take advantage of the reduced interest rates.
2. Adjustable-Rate Mortgage
Unlike a fixed-rate mortgage, an adjustable-rate mortgage is fixed for the initial term of the loan and begins to change with changes in market interest rates. The adjustable-rate mortgage is usually fixed for the first five to 10 years of the mortgage period.
The fixed interest rate is often below-market rate, and it makes the loan inexpensive for the period when the fixed interest rate remains in effect. Upon the expiry of the fixed interest rate period, the interest rate is adjusted upwards or downwards, depending on prevailing market rates.
If the market interest rate is lower, the borrower will pay lower monthly repayments than if the interest rate was still fixed. However, if the market interest rates increase, the borrower will be required to pay higher monthly payments, which may not be affordable.
Therefore, although the adjustable interest rate may benefit the borrower when the interest rates are lower, it makes monthly payments unpredictable after the fixed interest rate period ends.
Home Mortgage Payment
Home mortgage payment refers to the amount that the borrower pays every month towards repayment of the mortgage. The monthly mortgage payment comprises the following components:
The principal amount is the amount left to pay on the loan after each repayment. A portion of the monthly repayments automatically goes towards paying the loan principal.
For example, if the borrower borrows $300,000, and pays off $50,000, the principal amount is $250,000. Home mortgages are structured in a way that principal payments start low and increase with each mortgage payment.
The interest is the amount paid each month towards the mortgage based on the agreed-upon interest rate. If the interest rate is fixed, the borrower will pay a fixed interest on the loan for the life of the loan.
With an adjustable-rate mortgage, the interest paid may vary from one period to another. The interest rate charged on a mortgage determines the size of a mortgage payment. For example, a higher interest rate translates to a higher mortgage payment.
Mortgage payment also includes property taxes that are assessed by the government. These taxes are calculated yearly, and the monthly mortgage payments may include a portion of these taxes.
The annual property taxes are divided by the number of monthly mortgage payments in a year and held in an escrow account until the taxes are paid.
Insurance payments are included in each mortgage payment that the borrower makes, and are held in escrow until the payments are due.
The main types of insurance include property insurance and private mortgage insurance (PMI). The latter is mandatory for homeowners who purchase a home with a down payment that is less than 20% of the cost.
CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:
Take your learning and productivity to the next level with our Premium Templates.
Upgrading to a paid membership gives you access to our extensive collection of plug-and-play Templates designed to power your performance—as well as CFI's full course catalog and accredited Certification Programs.
Already have a Self-Study or Full-Immersion membership? Log in
Access Exclusive Templates
Gain unlimited access to more than 250 productivity Templates, CFI's full course catalog and accredited Certification Programs, hundreds of resources, expert reviews and support, the chance to work with real-world finance and research tools, and more.