Yahoo Finance Spotlight: What is a mortgage?

In this Yahoo Finance Spotlight, we outline some of the most important steps to buying a new home and break-down the different parts of a mortgage loan.

Video Transcript

ADAM SHAPIRO: With mortgage rates near all-time lows and US home prices reaching all-time highs, you might be hearing the term mortgage more often than in years past.

TENDAYI KAPFIDZE: Mortgage rates are probably going to remain attractive for, you know, probably a long time, probably all of this year, a good bit into 2022.

ADAM SHAPIRO: So what exactly is a mortgage, and should you start thinking about getting one? Put simply, a mortgage is a loan that uses one's property as collateral to help a buyer purchase a home. There are many different types of mortgages, and finding the right one for you will depend on several factors, including your credit and what type of property you're looking to buy.

There's the conventional loan backed by a private lender like a bank or credit union, a government-issued FHA loan insured by the federal government, which doesn't require a large down payment or high credit score, and there's a jumbo mortgage. As the name suggests, those are loans that exceed the limitations set by the Federal Housing Finance Agency and may not be guaranteed because they're a riskier loan.

A typical mortgage is paid off over 15 or 30 years. It depends on the loan term that you agree to. Once you secure the mortgage you want, your monthly payments will consist of two parts, principal and interest. The principal amount is the money you initially borrowed to purchase your home. The interest payment is a fee you pay the lender for borrowing its money. It's based off a number of factors, most importantly, the Fed funds rate set by the Federal Reserve Bank, which as you may have heard, is effectively near zero.

JEROME POWELL: With regard to interest rates, we continue to expect that it will be appropriate to maintain the current 0% to 0.25% target range for the federal funds rate until labor market conditions have reached levels consistent with the committee's assessment of maximum employment and inflation has risen to 2% and is on track to moderately exceed 2% for some time.

ADAM SHAPIRO: The total amount of interest you pay on your mortgage will vary depending on the interest rate and term of the loan. And by reducing that 15% to, let's say, 3%, You can see just how much that impacts your total payment over time. That super-low rate is part of the reason for the red-hot real estate market and why the term mortgage is popping up in conversations all across America.