What is a Mortgage?
How mortgages work, what your monthly payment covers, the difference between fixed and adjustable rates, and how amortization determines what you actually pay.
What is a mortgage?
A mortgage is a loan used to purchase real estate — typically a home. The property itself serves as collateral, meaning the lender can take ownership if you stop making payments (a process called foreclosure).
Unlike a personal loan, a mortgage is secured debt. Because the lender has a physical asset backing the loan, interest rates are significantly lower than unsecured borrowing like credit cards.
Most mortgages in the US are paid back over 15 or 30 years through fixed monthly payments. At the end of the term, the loan is fully paid off and you own the property outright.
What does a monthly payment cover?
A standard mortgage payment is often described with the acronym PITI:
How amortization works
Amortization is the process of spreading your loan payments over time so the balance reaches zero at the end of the term. Every payment is the same size, but the split between principal and interest changes each month.
Early in the loan, most of each payment goes toward interest. Over time, as your balance drops, the interest portion shrinks and more goes to principal. This is why the first years of a mortgage feel like you're barely making a dent.
Example: $300,000 at 7%, 30-year fixed
Monthly payment: $1,996 Payment #1: Interest → $1,750 (87.7%) Principal → $246 (12.3%) Balance → $299,754 Payment #180 (year 15): Interest → $1,145 (57.4%) Principal → $851 (42.6%) Balance → $195,400 Payment #360 (final): Interest → $12 Principal → $1,984 Balance → $0
Over 30 years, you'd pay approximately $418,000 in interest on a $300,000 loan at 7% — more than the loan itself. This is why extra principal payments early in the loan dramatically reduce total interest paid.
Fixed-rate vs. adjustable-rate mortgages
Fixed-rate mortgage (FRM)
The interest rate stays the same for the entire loan term. Your principal and interest payment never changes. Most US homeowners choose a 30-year or 15-year fixed. Predictability is the main advantage — you know exactly what you owe every month for decades.
Adjustable-rate mortgage (ARM)
The rate is fixed for an initial period (typically 5, 7, or 10 years), then adjusts annually based on a market index. A 5/1 ARM means fixed for 5 years, then adjusting every 1 year. ARMs start with a lower rate than fixed-rate loans, but carry the risk of higher payments if rates rise. They make sense if you plan to sell or refinance before the adjustment period begins.
15-year vs. 30-year mortgage
The two most common loan terms come with a significant tradeoff:
$300,000 loan at 6.5% (30-yr) vs. 6.0% (15-yr)
30-year 15-year
Monthly pmt: $1,896 $2,532
Total paid: $682,800 $455,760
Total interest: $382,800 $155,760
Interest saved by choosing 15-year: ~$227,000The 15-year saves over $200,000 in interest and builds equity twice as fast. But the higher monthly payment requires a stronger income. Many financial planners recommend the 30-year mortgage paired with investing the payment difference — if investment returns exceed the mortgage rate, you come out ahead financially, with more flexibility month to month.
Frequently asked questions
- How much do I need for a down payment?
- Conventional loans typically require 3–20% down. Putting down less than 20% usually requires private mortgage insurance (PMI), which adds 0.5–1.5% of the loan amount per year to your payment. FHA loans allow 3.5% down with a credit score of 580+. VA loans (for veterans) and USDA loans (rural areas) allow 0% down. A larger down payment reduces your monthly payment and eliminates PMI, but leaving yourself cash-poor at closing creates its own risks.
- What credit score do I need for a mortgage?
- Conventional loans typically require a minimum score of 620, with the best rates reserved for scores above 740–760. FHA loans accept scores as low as 500 (with 10% down) or 580 (with 3.5% down). A higher score directly lowers your interest rate — the difference between a 680 and 760 score on a $300,000 loan can be 0.5–1.0% in rate, costing or saving tens of thousands over the life of the loan.
- What is PMI and when can I remove it?
- Private mortgage insurance (PMI) protects the lender if you default, and is required when your down payment is less than 20%. By law (Homeowners Protection Act), lenders must cancel PMI automatically once your loan balance reaches 78% of the original home value. You can request cancellation at 80% LTV. Some loan types (like FHA loans originated after June 2013 with less than 10% down) require mortgage insurance for the life of the loan — a key reason to refinance into a conventional loan once you have sufficient equity.
- Should I make extra principal payments?
- Extra principal payments reduce your balance faster, shortening the loan and saving significant interest. Even one extra payment per year on a 30-year mortgage can shave 4–5 years off the term. However, whether to make extra payments depends on your rate and alternatives: if your mortgage rate is 3.5% and you can earn 7% in index funds, investing may produce better long-term results. If your rate is 7%+, paying it down is a guaranteed 7% return.