What Is a Mortgage and How Does It Work?

Understanding what a mortgage actually is

A mortgage is a loan used for the purchase or refinancing of a home. Practically speaking, it is the amount of money given to you by a lender for the financing of a home.

The mortgage loan has many parameters including, but not limited to:

• Interest rate of the loan
• Duration of the loan
• Type of financing - conventional, FHA, USDA, VA
• Amortization schedule - interest vs. principle portion of each payment over time
• Escrow account - for property taxes and homeowners insurance
• Private Mortgage Insurance (PMI) - if down payment is less than 20%

Mortgages are typically used when you do not have all of the money upfront for the sale of a home. If you do happen to have the entire upfront cost, you might still choose to mortgage the property if you do not want to give up such a large sum of money, all at once.

Is a mortgage the same as any other type of loan?

Yes and no.

A mortgage is specifically a loan given as financing for a home purchase, or refinancing. As collateral for such a large amount, the home is typically put up against the value of the home just in case you stop making payments to them. If payments should stop, the home could then be used as collateral for "repayment" of the loan. I use the term "repayment" very loosely because you lose more than just a home in this process. In the process of losing a home due to missed mortgage payments (essentially a foreclosure), your credit score will be ruined. 

Keep in mind that this black mark (i.e. foreclosure) stays on your record for 10 years. Avoid this at all costs if you ever hope to receive any other loans or favorable terms on lines of credit.

Lenders typically get into business to lend money, not to own homes. They want your money, not the house. I have heard of many people getting away with up to a year's worth of missed payments prior to the lender foreclosing on the property. This is proof of concept that lenders really don't want to be homeowners.

What is a mortgage "pre-approval" or "pre-qualification"

The initial process of obtaining a mortgage is to receive a pre-approval or a pre-qualification. Be advised, these are not the same thing. These two terms are often used interchangeably, but they differ in some important ways. 

A pre-qualification is solely based on information that you provide to the lender. This is simply a way to help you "ballpark" the amount of money you can hope to spend on a home. This is by no means a commitment nor is it a hard number to use when making home buying decisions.

A pre-approval is a much deeper dive into your history including, but not limited to:

• 30 days worth of pay stubs
• Your residential information from at least the last 2 years
• Financial statements including, but not limited to
  • Checking and Savings accounts
  • Taxable brokerage accounts
• Two years worth of tax returns- W-2s
• Social Security number to allow the lender to pull your credit history/report

​The pre-approval is a much firmer commitment to lend you a given amount of money. Essentially, a pre-approval is a mortgage loan application without a specific property affixed to the loan application.

How does the rest of the mortgage process work?

After obtaining a pre-approval letter (highlighted above), the potential buyer includes this in an offer on a particular home. If the offer is accepted, the potential buyer typically has a period of less than 10 days to officially apply for a loan with a lender. This is the time where most people "shop" around for the best quotes before submitting a formalized application. Beware however, you really do not have a ton of time to do your shopping so move forward wisely.

Around the same time as you are gathering documents for your mortgage application, you will be arranging to have the property inspected (if you choose) and place "earnest money" in an account based on the terms of your contract.

As for the application process itself, the lender will now perform any final verification of employment, income, and assets. The lender will also attain details on the specific property for which you intend to purchase following the seller's acceptance of your offer. The lender will look to have the following done prior to fully approving your loan:

• A property appraisal to confirm the value/condition of the home
• Hiring of a title company to check the status of the title on the home

If everything checks out and terms are acceptable (interest rates, loan duration, loan type, etc.), you will move towards closing on your mortgage.

Closing on your mortgage involves meeting with the lender and your real estate agent (and any other necessary parties depending on your state's rules/regulations). This is where you will sign your mortgage papers. This is also typically when your down payment and closing costs are due, in full.

Final Thoughts

As always, this is not to be interpreted as financial advice. Check your local rules and regulations as some of the information will ultimately differ according to where you live or desire to live.

Above is a summary of the basic "moving parts" surrounding mortgages. It is important to understand the nuts and bolts of a mortgage since it will likely be the largest financial transaction of your life.

The creation of mortgages permits many to attain home-ownership where it would otherwise be impossible due to limited income and finances. 

There are many more things to know about mortgages. Learn everything you can. Knowledge is power.

Best of luck.