What to Know Before Applying for a Mortgage

If you’ve never purchased a home or property, the process can seem overwhelming.

After all, a home costs a lot of money, and when you add in all the lingo (amortization, conforming, closing costs, etc.), borrowing that large amount of money becomes even more stressful.

But there's no need to be afraid! People take out mortgages every day, and you can too. Here's what you need to know, so you can go into the process prepared.

What Is a Mortgage?

A mortgage is a loan you take from a bank to purchase a house. You'll likely put some money down and then borrow the rest.

The terms of the mortgage determine how much you'll pay in interest, how many years until you fully own the home, and what rights the mortgage lender has if you don’t make payments on time. 

Taking out a mortgage is a major financial obligation — the property is the collateral your lender uses if you default on the loan. That means if you don't pay your mortgage, the lender can take your home.

There are several types of mortgages, and most come with minimum credit score requirements and a limit on how much you can borrow. 

Basic Mortgage Terms to Know

Here are some of the most common mortgage terms to know as you begin the homebuying process:

• Amortization: The process of paying off a loan with a set payment schedule, resulting in full payoff by the loan term’s end
• Principal: The amount of the loan
• Annual percentage rate (APR): The annual cost of the loan, including interest, mortgage points, broker fees, and other costs
• Private mortgage insurance (PMI): Payment required on conventional loans with less than a 20% down payment
• Homeowner’s insurance: Coverage in case of damage or loss to the home, property, or assets within
• Property taxes: Taxes charged by the county or other local jurisdiction
• Prequalification: An early step in which a lender estimates how much you can borrow
• Preapproval: When your lender has examined your financial documents and set an amount they will lend you
• Down payment: The amount you pay upfront for your home
• Conforming loan: A loan that meets the criteria of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac)
• Non-conforming loan: A loan that exceeds the loan limit of a conforming loan
• Closing costs: Percentage-based fee charged at the time of closing, usually 3% to 6% of the loan balance
• Equity: The amount, or percentage, of your home’s value that you own

Types of Mortgages

You'll most commonly hear about conventional mortgages, which are backed by private institutions like banks and credit unions — not by the federal government. They typically come with more stringent criteria for borrowers.

But mortgages aren’t one-size-fits-all. Conventional mortgages are broken down into further categories, and there are also mortgages backed by the government, which have different criteria.

Here are the various types of mortgages to consider. 

Conforming vs. non-conforming mortgages

• Conforming mortgages must follow guidelines set by the Federal Housing Finance Agency (FHFA). This agency sets maximum loan limits for borrowers. 
• Non-conforming mortgages aren't bound by the FHFA guidelines. Some examples of non-conforming loans are USDA, VA, and FHA loans, which typically have more relaxed criteria for down payments and credit scores. 

Fixed-rate vs. adjustable-rate mortgages

• Fixed-rate mortgages have a set interest rate that doesn't change for the entire term of the loan. You can count on the same payments throughout the 15, 20, or 30-year term. 
• Adjustable-rate mortgages (ARMs) can have fluctuating interest rates. Some ARMs have specific guidelines about when or how often the rate may change. 

Government mortgages

You can also look into FHA loans, VA loans, and USDA loans through the U.S. government, which are often easier to obtain. 

However, the term “easier” refers to the ability to take out a mortgage with a lower credit score or a smaller down payment. In other ways, government-backed mortgages are stricter and harder to qualify for. 

• FHA loans are through the Federal Housing Administration, and borrowers can qualify with lower credit scores and lower down payments. FHA loans are particularly appealing to first-time homebuyers. 
• USDA loans are for buyers with a low-to-moderate income level. Buying a home in an eligible rural area could mean you don’t even need a down payment. 
• VA loans benefit federal service members. Some mortgage lenders don’t require a down payment for VA loans, and borrowers often receive lower interest rates and don’t have to pay private mortgage insurance (PMI). 

What to Consider When Shopping for a Mortgage

When you're shopping for a mortgage, you’ll want to consider the interest rate, down payment, and loan term. You'll also want to be clear on what fees will be charged.

Closely examine your own finances to understand what’s reasonable for you. Getting a mortgage is a huge financial step, and it’s not one to take lightly, especially if it’s your first time buying a home.

Research your options and find out what you qualify for. Also consider what you can financially manage. For example, you don’t necessarily want to go with the lender that offers you the highest loan amount if the mortgage payment is going to overextend your budget.

Or, if deciding between a 15-year and a 30-year term, look realistically at the options. Certainly, a 15-year mortgage is appealing because you’ll own your home in less time and pay less in overall interest, but you’ll also need to pay much more each month. 

Talk to multiple lenders to gain a full picture of what you can afford and what they will approve. Discuss the types of mortgages they offer, the interest rate they would charge you, whether it’s a fixed or adjustable rate, the loan term, closing costs, and other fees they may charge.

For example, some lenders charge prepayment fees. Or, if you buy certain types of homes, there may be homeowner association (HOA) fees to consider. 

Documents to gather before shopping for a mortgage

Banks and lenders will need to see evidence of your ability to take on such a large financial obligation. You'll need to gather the following documentation to compare loan offers:

• Income verification: Pay stubs, W-2 income tax statements (usually for the past two years), names and contact information for employers
• Debt information: Records of current student loan debt, credit cards, vehicle loans, etc. 
• Assets: Documentation of checking and savings accounts, brokerage accounts, stocks, and gifts
• Personal information: Social Security information and other personal data for credit inquiries

READ MORE: How To Get a Mortgage

What's Included in Your Mortgage Payment?

Most mortgages involve putting a certain amount down, called the down payment, and then spreading the remainder of the loan over a set period of years.

But your monthly payment doesn’t just include the amount borrowed. In addition to the principal, it also includes interest, taxes, and insurance. 

It's important to be aware of this, so you aren’t caught off guard when your mortgage payments begin. 

Principal

The loan principal is the remaining loan balance after you’ve made your down payment, if any. If you put 20% down on a $300,000 house, for example, your remaining balance would be $240,000. 

Loan interest

Your interest rate is calculated as a percentage of the loan principal. Your credit score, loan-to-value ratio (how much you’re borrowing compared to the full property value), and down payment percentage all affect how high your interest rate will be. 

Escrow

You'll also pay into an escrow account for property taxes and homeowner's insurance.

The lender estimates the annual cost of property taxes and then divides it equally across your monthly payments. The mortgage provider holds the funds until the taxes are actually due, then makes the full tax payment on your behalf. 

It works the same with your homeowner's insurance. Many lenders collect insurance payments each month and retain the funds in an escrow account.

PMI

Private mortgage insurance (PMI) may also be factored into your monthly payments. PMI isn’t required for all mortgages, but it is required for conventional mortgages if you don’t put down 20%. PMI is protection for the lender in case you default on the loan. 

Once your principal drops to 80% of the original property value, you can request to have PMI dropped from your payments. 

PMI is one reason that it’s best to wait until you can make a 20% down payment, if you're going for a conventional mortgage. That fee increases your monthly payment significantly.

FAQs

TL;DR: How Mortgages Work

If you’re buying a home and don’t have all the cash, a mortgage is the loan that lets you spread the cost over years. Before you jump in, get clear on your finances, shop around for lenders, compare offers (interest rate, fees, term), and always read the fine print!

You’ll need to choose between fixed or adjustable rates, and understand what goes into your monthly payments (principal, interest, taxes, insurance — plus maybe PMI). Knowing this all upfront will prevent any surprises when you get your first mortgage bill!