How Does a Mortgage Work?

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Homes in the U.S. often cost hundreds of thousands of dollars. Most consumers don't have enough cash saved up to buy a home outright. Instead, they opt for a mortgage and finance the purchase of the property. After making an initial down payment, mortgage payments are comprised of loan principal and interest payments, and often taxes and insurance as well.

Mortgage BasicsSimply put, a mortgage is a loan to purchase a home. When a bank issues you a mortgage, you own the home but the house is collateral for the loan. That means, if you default on payments, the lender has the ability to foreclose on the home and transfer the title into its name. You'll make periodic monthly payments to pay down the principal and interest incurred on the loan. After you finish making your payments, you'll own your home free and clear.

Down PaymentYou may be required to make a down payment in order to secure the mortgage. Down payment requirements vary depending on the lender and the loan you choose. The larger of a down payment you make, the less interest you'll pay over the life of the loan. If you put down a large down payment -- typically, a 20 percent down payment will suffice -- you may also be able to secure a lower interest rate. A 20 percent down payment may also allow you to avoid private mortgage insurance, which protects the lender in case you default on the loan. You may also be able to purchase mortgage points to lower your interest rate.

Monthly PaymentsThe size of your monthly payments will depend on the purchase price of your home, you interest rate, and the length of your mortgage. Many mortgage loans have terns between 15 and 30 years. The longer your mortgage is, the lower your monthly payment will be. However, you'll pay more interest overall with a long mortgage than you will with a short one.

Taxes and InsuranceYour county tax assessor will levy a real estate tax based on the value of your home. In addition, your lender may require that you maintain homeowners insurance, which covers certain damage that could occur to your home. If you have an escrow account -- which are required for Federal Housing Administration mortgages -- your property tax payments and home insurance premiums also will be included in your monthly payment. Otherwise, you'll pay these expenses directly to your county tax assessor and insurance provider.

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