mortgage definition

What Is a Mortgage? | The Truth About

Mortgage Definition

  • The word “mortgage” is French in origin
  • And literally means death pledge in their native language
  • Yet the French use a different word for mortgage
  • Go figure, right…

Let’s start with the ultra basic: “What is a mortgage?”

Over here at The Truth About Mortgage, this is always the word of the day, as you might have guessed. Fortunately, the definition of mortgage has a somewhat interesting origin.

You’ve undoubtedly heard the word “mortgage” thrown around a million times. But you may not know that in the literal sense, it is defined as a “death pledge” in the French language.

Ironically, the French don’t actually use the word themselves (they use hypothèque, while Spanish speakers use the similar word hipoteca).

Broken down, the mort part (pronounced more) means death and the gage part (pronounced gahj) means pledge.

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This pledge dies (is terminated) when the mortgage is either paid off in full or the property is repossessed (foreclosed) by the bank if not paid as agreed (borrower defaults).

So that’s the literal definition of mortgage; now let’s look at the real-world application.

A mortgage can be referred to in a variety of different ways, with the most common being a “home loan.”

Some may refer to a mortgage as a “lien,” which represents a security interest by a lender on a piece of property. Whatever is left over from the original loan amount is referred to as the existing lien.

Others might refer to the mortgage as a trust deed, or deed of trust, which is a legal document that it used in some states to outline the terms of the agreement between the homeowner and the lender.

You can also use the word as a transitive verb to describe the conveyance of property, which is the legal process of transferring ownership in real property from one owner to another.

Some folks also combine two seemingly redundant words when they say mortgage loan. Or they’re just being really, really specific to make sure no one is led astray.

How Mortgages Work

how mortgages work

  • A mortgage is simply a loan used to finance real property
  • Otherwise known as a house, condo, or townhome
  • You can get one from the bank or even a non-bank lender
  • Assuming you can’t afford to buy the property with cash (or prefer not to)

Now that we’ve discussed mortgage meaning, let’s move on to how they work.

Regardless of the many terms, definitions, and variations, a mortgage is essentially an agreement between a bank and a borrower to lend money in exchange for a piece of property.

By property, I mean residential real estate. It’s a fairly simple concept.

Instead of buying a home with cash, which most of us can’t manage, you take out a mortgage with a bank and repay it over a long period of time, typically 30 years.

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The lengthy term of a home loan allows payments (and home ownership) to be affordable. If mortgages only lasted 5-10 years, the monthly payments would be sky-high. And surely home prices would fall.

Bank/Mortgage Lender —> Mortgage —> Borrower/Homeowner

A bank, otherwise known as a mortgage lender, will loan you a specific amount of money that will need to be repaid in “X” amount of years at “Y” mortgage rate.

You can also obtain a home mortgage via a mortgage broker, who acts as a middleman, or from a non-bank lender, which is an institution that doesn’t collect deposits (they don’t offer checking/savings accounts).

In any case, you must go through the mortgage qualification process to get approved, but it’s not a guarantee everyone will be granted a mortgage.

A mortgage underwriter will decide your fate, and could deny you for any numbers of reasons, including spotty credit history, bad credit, expensive student loans, and just plain not being able to afford the monthly mortgage payment.

This is why a mortgage pre-approval is important, as is the use of an affordability calculator to determine how much mortgage you can take on before you begin comparing lenders and starting the underwriting process.

Generally, you must also provide a down payment for a portion of the sales price at the time of purchase, such as 3-20% depending on the loan type, though zero down options are also available if you qualify.

Your down payment will determine your loan-to-value ratio, which is an important factor when it comes to your mortgage rate.

Assuming you qualify for a mortgage, the bank will grant you a loan and you will go into contract with that lender and begin making regular monthly payments until your mortgage is paid in full or refinanced by another bank or lender, or if your home is sold before maturity.

The property acts as collateral in exchange for the mortgage. So if you don’t make your mortgage payments on time, the issuing bank has the right to take your home. This is known as foreclosure.

If you sell your home before the mortgage term ends, the proceeds of the sale will be used to pay off the remaining mortgage debt.

[How mortgage interest is calculated.]

There are five main types of mortgage transactions:

– Purchase Money Mortgage
– Rate and Term Refinance
– Cash-Out Refinance
– Home Equity Line of Credit
– Home Equity Loan

While you’re here, you may also want to learn more about how mortgage refinancing works. There are also reverse mortgages for seniors who wish to tap into their equity without having to make a monthly payment.

Most Mortgages Have 30-Year Terms

  • The typical mortgage is paid back over a lengthy 30 years
  • While it’s a very long time to pay off a loan and gain full ownership
  • The extended loan amortization period
  • Allows monthly mortgage payments to be affordable for homeowners
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Most mortgages are due in full in 30-years and also based on a 30-year amortization. That is, the total loan amount, or lien(s) will need to be paid off in 30 years, or in 360 months.

Amortization refers to how the mortgage is paid off.  It is essentially the way your mortgage payments are distributed on a monthly basis, detailing how much interest and principal will be paid off each month for the duration of the mortgage term.

Your outstanding loan amount is essentially your principal balance, which shrinks over time as monthly payments are made.

In the case of a 30-year fixed mortgage, the mortgage is paid off in equal amounts every month until the mortgage balance is zero.  At that point, you would have full ownership of the associated property.

[Why are mortgages mostly interest?]

The difference between the mortgage balance and the value of the property is known as home equity, which you can access via sale, refinance, or home equity line of credit.

Also note that there are other less common loan terms such as 15-year, 20-year, 40-year, and even 50-year loan programs.

But for the sake of simplicity, let’s focus on the 30-year amortization type, which is far and away the most popular.

Mortgage Example

Purchase Price $300,000
Down Payment $60,000
Loan Amount $240,000
Loan Type 30-Year Fixed
Interest Rate 4%
Monthly Payment $1,145.80
Total Interest Paid $172,488.00
Total Amount Paid $412,488.00

Now let’s take a look at a simple mortgage example to get a better grasp of how it all works.

Let’s pretend you want to buy a $300,000 home, and you’ve got 20% available for down payment.

Once you do your mortgage shopping and find a lender to work with, you’ll have to fork over $60,000 plus closing costs.

After the loan funds, you’ll have to pay back the $240,000 over the course of 30 years.

In our example, you’ve got a 30-year fixed set at 4%, which equates to a $1,145.80 monthly payment that doesn’t change for the full 360-month term.

Assuming you hold the loan until maturity, you’ll pay $172,488.00 in interest to the bank, and $412,488.00 total.

Once the mortgage is paid off in full, you will be free and clear on the property, meaning you’ll only be on the hook for property taxes and homeowners insurance going forward.

At any time during the loan term, you can sell the property, refinance the mortgage, or pay it off ahead of schedule, assuming no prepayment penalties apply.

Most homeowners don’t keep their mortgages for the full term, or even close to it. Average tenure is closer to 10 years or less.

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There Are Plenty of Mortgage Options Out There

  • You can go with a fixed-rate loan
  • With payments that don’t change during the entire loan term
  • Or try your luck with an ARM
  • Which can adjust over time but may provide an initial interest rate discount

When searching for a loan program, you will be presented with a variety of options from a six-month adjustable-rate mortgage (ARM) to a 30-year fixed product.  Both are based on 30-year amortization, but can differ greatly in rate.

The 30-year fixed product is pretty clear.  It’s simply a fixed rate for the entire 30 years of the loan.

It never changes, and the rate and payment you make the first month is also the rate/payment you will make the last month, or the 360th month to be exact.  Learn more about fixed-rate mortgages.

The six-month ARM product is a bit more complicated. For the first six months, the interest rate will not change.

But after those initial six months, the rate will become variable (adjustable), though it will still be based on a 30-year amortization. The loan program will be tied to a mortgage index, such as the LIBOR (London Interbank Offered Rate) and will also contain a margin agreed upon by the bank or lender.

When you combine the two, you will find your fully-indexed rate. The margin doesn’t adjust, but the index will do so on a daily basis, which will affect your monthly payment.

Learn more about how adjustable-rate mortgages work. This means your payment can change throughout the life of the loan. It also explains why most borrowers prefer fixed-rate mortgages.

Aside from those basic mortgage types, there are also different options such as FHA loans, interest-only mortgages, VA loans, and more. Be sure to explore the many choices available to you to ensure you get the best deal and save money.

Lastly, when pondering the idea of homeownership, be sure to remember to include things like mortgage insurance, homeowners insurance, and property taxes when using a mortgage calculator.

These are real, often unavoidable costs, which must be factored in to your decision.

Even if the mortgage payment is cheap, the addition of those mentioned items plus maintenance can make owning a home unaffordable.

While real estate can be a great investment, the money you borrow must ultimately be paid back.

And when comparing lenders, consider mortgage points and other closing costs, which can greatly affect your true mortgage rate (APR).

If you’re looking for quick definitions to other mortgage-related terms, check out my mortgage glossary.  And if you’re not sure what mortgage to go with, see my article on which mortgage is right for me.

For many more mortgage basics and even more complex definitions, check out my mortgage help topics page as well.