Understanding Mortgages: A Guide to the Different Types and How They Function

Understanding the complexities of buying a home can lead to long-term success for homeowners. Habitat collaborates with families in need of secure, affordable housing, offering access to home loans, commonly known as mortgages. With over four decades of experience, we help homebuyers gain the necessary tools and resources to achieve financial independence and stability.

This guide explores common types of mortgages and how Habitat enhances access to affordable options.

What is a Mortgage?

A mortgage is a loan secured by real estate, meaning the home is used as collateral. If the borrower defaults, the lender can repossess the property. Mortgages can be used for commercial or residential purposes, such as purchasing or refinancing a home.

Since most homebuyers lack the funds to buy a home outright, they obtain a mortgage to cover the purchase price. For instance, if Janet wants to buy a $200,000 home and has $40,000 for a down payment, she will need a $160,000 mortgage. Monthly payments on her mortgage will reduce her debt and increase her equity in the home.

Understanding Mortgage Terms, Interest, and Down Payments

Mortgages vary in terms of duration, interest rates, and down payment requirements. The most common mortgage term is 30 years, meaning the borrower makes monthly payments for 360 months.

Lenders charge interest to cover loan costs, account for the time-value of money, and mitigate lending risks. Interest rates can be fixed or variable, depending on the borrower’s credit profile.

A fixed-rate mortgage keeps the principal payment consistent throughout the loan term, while a variable-rate mortgage adjusts based on market conditions. For example, with a 30-year fixed-rate mortgage at 4.5% interest, Janet’s principal payment remains the same, although her monthly payment may include varying amounts for taxes and insurance, which are typically escrowed by the lender.

Preparing for a Mortgage

When applying for a mortgage, lenders evaluate your financial situation, including debt-to-income ratio, savings, income, credit history, and credit score. Habitat partners with prospective homeowners to help them become mortgage-ready, which might involve increasing savings, improving credit scores, reducing debt, and managing budgets.

Mortgage calculators can help estimate monthly payments. Habitat and financial experts advise that spending more than 30% of income on housing can lead to financial strain, whereas affordable mortgages enable homeowners to build equity and save for the future.

Exploring Other Mortgage Options

Prospective homeowners might consider different mortgage options, such as federally backed loans or portfolio loans. Federally backed loans, insured by agencies like the FHA, USDA, or VA, often have favorable terms for buyers with lower credit scores and smaller down payments. They also include protections for struggling homeowners.

Most U.S. mortgages are sold to secondary agencies, requiring them to meet specific standards. Portfolio loans, which are not sold to these agencies, offer more flexible terms and can be suitable for buyers with lower credit scores or higher debt-to-income ratios. However, these loans may come with higher fees and stricter penalties.

Habitat’s Role in Affordable Mortgages

As a leader in providing affordable mortgages, Habitat is dedicated to helping under-resourced families achieve homeownership. Affordable and responsible mortgages benefit entire communities, but rising housing costs and a lack of affordable homes have exacerbated a nationwide affordability crisis, especially in underserved areas. Habitat plays a crucial role in expanding access to affordable homeownership, allowing more families to experience the stability and joy of owning a home.