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Mortgage Basics

What is a mortgage?

A mortgage is nothing more than a loan that you obtain to close the gap between the cash you have for a down payment and the purchase price of the home that you're buying. Homes in your area may cost $70,000, $170,000, or $770,000. No matter -- most people don't have that kind of spare cash.

Mortgages typically require monthly payments to repay your debt. The mortgage payments are comprised of interest, which is what the lender charges for use of the money you borrowed, and principal, which is repayment of the original amount borrowed.

How do I distinguish between fixed-rate mortgages and adjustable-rate mortgages (ARMs)?

Like some other financial and investment products, many different mortgage options are available for your choosing. Two fundamentally different types of mortgages exist, and they differ in terms of how their interest rate is determined: fixed-rate mortgages and adjustable-rate mortgages.

Before adjustable-rate mortgages came into being, only fixed-rate mortgages existed. Usually issued for 15 or 30-year periods, fixed-rate mortgages have interest rates that are fixed during the entire life of the loan.

- With a fixed-rate mortgage, your monthly mortgage payment amount does not change. No surprises, no uncertainty.

- Adjustable-rate mortgages (ARMs for short) have an interest rate that varies. The interest rate on an ARM typically adjusts every six to twelve months, but it may change as frequently as every month.

- The interest rate on an ARM is primarily determined by what's happening overall to interest rates. When interest rates are generally on the rise, odds are that your ARM will experience increasing rates, thus increasing the size of your mortgage payment. Conversely, when interest rates fall, ARM interest rates and payments generally fall.

Why do I need homeowner's insurance?

Homeowner's insurance is mandatory. When you purchase a home, your mortgage lender won't allow you to close the purchase until you've demonstrated that you have proper homeowners insurance. Lenders usually insist that you pay the first year's premium on said insurance policy at the time of the closing.

What should I expect to pay in closing costs?

On the day when a home becomes yours officially (known as closing day), you will have to pay fees for the services of several parties. In a typical real estate deal, closing costs total 2 to 5 percent of the purchase price of the property. You shouldn't ignore them in figuring the amount of money you need to close the deal. Exact fees vary by property cost and location. For more detailed costs read the section on Closing Costs below.