Conclusion: How Mortgages Work
A mortgage is a home loan that uses the home as collateral. Most are set up to be paid off over 15 or 30 years. Most borrowers end up paying one-twelfth of their annual bill for taxes and insurance with each payment. That money is set aside in an escrow account and the tax and insurance payments are made on time by the mortgage servicer.
A mortgage payment contains four and sometimes five components. The first four are principal, interest, taxes and insurance. In industry shorthand, these are called PITI. Some borrowers pay monthly mortgage insurance premiums, too.
There are two main types of mortgages: fixed rate and adjustable rate. A fixed-rate mortgage has one rate that remains for the life of the loan. An adjustable-rate mortgage, or ARM, has a rate that adjusts periodically as overall interest rates go up and down. Some home loans are a hybrid of fixed and adjustable rates.
Deciding whether to get a fixed or adjustable is a matter of weighing the pros and cons of each. Initial rates on ARMs are lower than for comparable fixed-rate mortgages, but the rates can rise. The decision whether to get an ARM or fixed depends on matters such as how long the borrower plans to live in the house, how often the ARM rate adjusts, how high the payment could climb and what's happening to interest rates overall -- are they moving up or down?
People with flawed credit can qualify for mortgages, but with higher rates and stricter terms. These loans are called subprime or nonprime mortgages. Most subprime mortgages are legitimate, but a subset of them, called predatory loans, harm borrowers.
There are many types of mortgage lenders, and the distinctions between them sometimes are blurry. Mortgage lenders, mortgage brokers and banks, thrifts and credit unions make up the vast majority of the lender market.