So you’re dreaming of buying your very own house! The problem is houses are super expensive—which leads many home buyers to take out a mortgage.
The spooky thing about the word mortgage is that it’s made up of old French and Latin words that mean dead pledge. To put it another way, a mortgage is a loan you can either pay back quickly until it’s dead, or a loan you can pay back slowly until you’re—well, you get the idea.
At Ramsey, we don’t want you to be stuck paying off your house for the rest of your life! So we’re going to show you what a mortgage really is and how it works so you can have the confidence to pay off your house as fast as possible.
Let’s get started!
What Exactly Is a Mortgage?
A simple definition of a mortgage is a type of loan or large sum of money you borrow from a lender to help you buy a house. The house you get with the loan serves as collateral for your lender so that if you don’t make your monthly payments, they can take your home in foreclosure.
If you’re not familiar with Ramsey, the first thing we teach people is debt is dumb! And since a mortgage is debt, we’ll always tell you the best way to purchase a house is with 100% cash. And people do this all the time!
But we know saving up that much money isn’t always realistic for everyone’s timeline. Plus, your house is one asset that actually grows in value over time. That’s why we don’t yell at you for getting a mortgage—as long as it’s one you can afford and pay off fast!
How Do Mortgages Work?
Okay, when you take out a mortgage, your lender gives you a specific amount of money to buy a house—usually just a percentage of the total home price.
If you’re smart, you’ll pay 10–20% or more of the total home price by yourself in cash before you borrow the other 80–90% or less from a lender.
You’ll also sign a mortgage note—the legal document that sets the terms of the mortgage. This includes:
- Amount of money borrowed
- Costs your lender will charge you
- Repayment plan
- Timeline of money to be paid back
- All the nitty-gritty details
Then comes the interest. Whatever amount of money you put down on your house will affect how much your lender charges you in interest for your mortgage. The less you need to borrow, the less interest you’re required to pay—and the sooner you’ll pay off your house!
Who’s Involved in the Mortgage Process?
The mortgage process involves two main parties—the borrower and the lender.
This is a person who borrows money from a lender to pay for a house. You might be told you can get a bigger loan to buy a bigger house if someone cosigns for you. But cosigning is a bad idea because it usually means you’re not financially ready to buy a house.
A lender loans out money so a borrower can buy a house. But first, the lender examines the borrower’s personal finances to see how much they’re willing to loan. If there are no red flags in the borrower’s financial history, the lender will likely approve the borrower for the loan.
There are different kinds of mortgage lenders. You might work with a mortgage broker to help you pick the right lender. Or you might work with one of these lenders right off the bat:
- Credit union
- Direct lender
Whatever you do, make sure you work with a mortgage professional you trust—someone who takes the time to explain things to you, like our friends at Churchill Mortgage.
Get the right mortgage from a trusted lender.
Whether you’re buying or refinancing, you can trust Churchill Mortgage to help you choose the best mortgage with a locked-in rate.
Mortgage Terms and Definitions
When you start shopping for a mortgage for the first time, you’ll probably come across mortgage jargon you don’t hear every day. But don’t worry—we’ll give you a leg up on some common mortgage terms.
This big, scary word refers to how you pay off your mortgage over time through monthly payments. Your lender will probably walk you through an amortization schedule, which is basically a visual countdown to the end of your mortgage. It shows you how much of each payment will go toward interest and principal—until you pay off the house!
This is the cash you pay up front—a percentage of the total home price. Remember to aim for 10–20% or more. But never go lower than 10%—it’ll cost you thousands more in interest and private mortgage insurance (more on this later). For help on how to reach that 10–20% amount faster, check out our Saving for a Down Payment Guide.
A mortgage rate or interest rate is basically a fee a lender collects for letting you borrow money. It’s based on a percentage of your mortgage balance. As you pay down your mortgage, you’ll pay less in interest.
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Your lender will determine the interest rate on your mortgage based on the length of your repayment plan, your personal financial history and the current economy. Most buyers have to pay fees called loan level price adjustments in the form of a slightly higher interest rate.
There are two mortgage rate options you should know about:
- Fixed-rate mortgages. These keep the same interest rate over the life of the loan. You’re locked into your rate once you sign those mortgage documents—regardless of market changes. This is the only type of mortgage rate we recommend at Ramsey since it helps you avoid rising rates.
- Adjustable-rate mortgages (ARM). An ARM loan usually has a set period of time when the interest rate doesn’t change. But after that, your rate can change based on several different factors—like with market trends. ARMs transfer the risk of rising interest rates to you—the homeowner. No thanks!
There are a ton of different mortgage options out there. Knowing the difference between each one could save you tens of thousands of dollars and decades of debt! That’s why we want you to know about them.
But we don’t want to put you to sleep by covering all the different types of mortgages here. So, instead, we’ll give you a brief overview of the most common ones.
Conventional loans generally require a 5% down payment. They’re backed by the mortgage lender themselves—so if you don’t make your monthly mortgage payments, the lender loses money on the loan. Conventional mortgages can be more difficult to qualify for, and they require higher down payments than government-backed loans.
Here are two of the most common conventional mortgages:
- 15-year fixed-rate mortgage: This is a home loan designed to be paid over a term of 15 years. It’ll generally have a higher monthly payment, but a lower interest rate than a 30-year mortgage. This is the lowest total cost mortgage—which is why it’s the only one we ever recommend at Ramsey.
- 30-year fixed-rate mortgage: This loan term is set for 30 years and will generally have the lowest monthly payment amount but the highest interest rates—which means you’ll pay much more over the life of the loan. In other words, it’s a rip-off!
Unconventional Mortgages (Government Loans)
The government provides a few ways to step onto the housing ladder with unconventional loans. These loans are backed by the government. That means if you don’t make your payments, your lender won’t lose money because the government has them covered.
If you get a government loan, a lender may be more willing to take a risk on you even if your financial history isn’t the best. But that doesn’t mean they won’t take the house away from you if you don’t make your mortgage payments. So beware—government loans don’t help the borrower in the long run.
Here are two of the most common government loans:
- FHA loans: These loans require a down payment of as little as 3.5%— which looks pretty nice for a lot of potential borrowers. But a lower down payment now means you'll pay way more in interest later.
- VA loans: These are backed by the Veteran’s Administration, and they don’t require down payments or mortgage insurance (but there is a funding fee). This may be tempting, but it’s risky. If you can’t put any money down on your home, you‘ll have high monthly payments—which makes it difficult to keep your home.
What Type of Mortgage Should I Get?
Remember, the only mortgage we ever recommend at Ramsey is the 15-year fixed-rate mortgage. The reason for this is because it has the lowest total cost compared to every other option.
Now, you might be tempted to choose the 30-year over the 15-year mortgage simply because the 30-year offers a lower monthly payment. But the 30-year mortgage is tens of thousands of dollars more expensive and keeps you stuck in debt twice as long!
Monthly Mortgage Payment
After borrowing money to purchase your house, you’ll start paying back that money at a set monthly mortgage payment. Keep in mind, that payment doesn’t only go toward paying back the money you borrowed.
Think of your mortgage payment as a pizza sliced up to pay for several different things, including:
- Principal. This is the initial amount of money you borrow for your home. The principal portion of your monthly payment is the part that actually goes toward paying your loan amount.
- Interest. Remember, this is the fee your lender charges you for borrowing money. Usually, shorter-term mortgages have lower interest rates, but your monthly payments are higher. That’s why it’s always better to pay off a mortgage in a shorter period of time instead of a longer period at a higher interest rate.
- Taxes. These are the property taxes you pay as a homeowner. They’re calculated based on the value of your house and vary by location and home price. Your lender collects these funds in an escrow account and makes your property tax payment for you during tax season.
- Home insurance. This covers the cost of your home if something disastrous (like a tornado or a fire) were to happen. Nearly all lenders require home insurance.
- Private mortgage insurance. Also called PMI, this is required if your down payment is less than 20%. It only protects your lender (not you) if you stop paying on your mortgage.
One word of advice here: Never buy a house with a monthly mortgage payment that’s more than 25% of your monthly take-home pay—otherwise, you’ll be house poor!
To help you stick to that 25% affordability rule, use our mortgage calculator to enter your down payment amount and try out different home prices within your budget.
Other Mortgage Fees
Here are some other fees related to getting a mortgage:
- Closing costs: These are all the fees associated with closing and setting up a mortgage, including an appraisal of the property, home inspection, the real estate agent’s commission, prepaid insurance and property taxes. These vary from lender to lender, so pay close attention and don’t be afraid to negotiate lower closing costs.
- Prepayment penalties: If you want to make extra payments so you can pay off your mortgage before the end of your loan term or if you want to sell your home before the end of your loan term, you may come across prepayment penalties. Never sign up for a mortgage with prepayment penalties.
- Interest rate vs. annual percentage rate: Don’t be fooled. The interest on your loan isn’t all you actually pay. The total rate you pay annually on your loan is your APR, which considers your interest rate and other fees charged over the life of your loan—like loan processing fees.
- Balloon payments: These are large, lump-sum payments due at the end of some loan terms. You’ll see these with super short-term loans usually from nonbank lenders. While we usually associate balloons with celebrations, these are some balloons you want to avoid! You don’t want to be on the hook for a large payment due all at once when you could be paying down your principal with steady, predictable payments.
- Negative amortization: If you fail to make your loan payments or only pay enough to cover the interest amount due, what you owe will be added to your loan’s principal. This will make your principal larger and your payments even bigger. The lesson here is this: Don’t miss your payments!
The Mortgage Process
Okay, now let’s look at the steps it takes to actually get a mortgage:
- Find a lender you trust.
- Get preapproved for a mortgage.
- Make an offer on a house.
- Wait for loan documents to finalize.
- Close on your house!
Sound simple enough? Most of the work will be on your lender. All you need to do is have all your personal financial records readily available—and be prepared to sign a mountain of paperwork!
Ready to Get a Mortgage?
If you want more help understanding mortgages and how to make the best decision for your budget when buying a house, connect with our friends at Churchill Mortgage. They actually care about helping you pay off your house fast.