Mortgage: a basic definition

Mortgages are special types of loans that typically carry interest rates that are lower than other lines of credit. These special loans are used to pay for houses, stretching the big expense over an extended period.

Home loans typically consist of two key components: principal and interest. Principal refers to the full amount of the original mortgage. If you paid a $20,000 down payment on a $100,000 house, you would need a mortgage for the remaining $80,000. That $80,000 would be your loan principal.

Interest refers to the profit that a lender makes in exchange for providing you with funding. The amount of interest that a lender earns grows over time. Typically, you will be given an interest rate in percentage points when you apply for a mortgage (e.g., four percent.) The specific interest rate varies depending on the lender and your financial situation.

When you make monthly payments to your mortgage lender, you are paying for both the principal and the interest. To keep your monthly payment low and stable, lenders will usually design your loan so that you are paying for the interest before you pay for the principal. Within this design, most borrowers are allowed to prepay if they want to and can afford to.

This is an important principle: the longer it takes for you to repay the principal, the more interest you will pay. As a result, it behooves the borrower to pay back the mortgage as quickly as possible. For example, a borrower with a 15-year repayment term on their fixed-rate mortgage will ultimately pay far less interest than another borrower with a 30-year term for the same loan.