How Mortgages Work
A mortgage is a loan secured by your home. Understanding four moving parts — principal, rate, term and escrow — explains almost everything about your payment.
The basic deal
When you take out a mortgage, a lender pays the seller for the part of the home you can’t pay in cash. In return you promise to repay that amount — the principal — plus interest, over a fixed number of years called the term. The home is collateral: if you stop paying, the lender can foreclose and sell it to recover what is owed.
Most U.S. home loans are fixed-rate mortgages: the interest rate, and so the principal-and-interest payment, stays the same for the whole term. Adjustable-rate mortgages (ARMs) start with a fixed period and then reset periodically based on an index, so the payment can rise or fall.
How the monthly payment is set
A fixed-rate mortgage uses an amortizing payment: the same amount every month, calculated so that the final payment brings the balance exactly to zero.
M = P × r / (1 − (1 + r)^−n)
P = amount borrowed, r = annual rate ÷ 12, n = number of monthly payments
For a $300,000 loan at 6.5% over 30 years, that is $1,896.20 a month. The rate has a large effect over three decades:
| Rate | Monthly P&I | Total interest |
|---|---|---|
| 5.5% | $1,703.37 | $313,212 |
| 6.0% | $1,798.65 | $347,515 |
| 6.5% | $1,896.20 | $382,633 |
| 7.0% | $1,995.91 | $418,527 |
| 7.5% | $2,097.64 | $455,152 |
A one-point difference in rate changes the payment by roughly $197 a month on this loan — and total interest by tens of thousands of dollars. That is why comparing lender quotes matters more than almost any other decision in the process.
Why early payments are mostly interest
Each month, interest is charged on whatever you still owe. At the start you owe the most, so most of the payment is interest. In the first month of our example, $1,625.00 of the $1,896.20 payment is interest and only $271.20 reduces the balance. As the balance falls, the split slowly reverses.
| After year | Principal paid that year | Interest paid that year | Balance |
|---|---|---|---|
| 1 | $3,353 | $19,401 | $296,647 |
| 5 | $4,346 | $18,409 | $280,833 |
| 10 | $6,009 | $16,745 | $254,329 |
| 15 | $8,310 | $14,445 | $217,679 |
| 20 | $11,491 | $11,263 | $166,998 |
| 25 | $15,890 | $6,865 | $96,916 |
| 30 | $21,978 | $782 | $0 |
This schedule is called amortization, and it is why extra payments early in a loan save so much interest: each extra dollar stops accruing interest for decades. Our amortization guide goes deeper, and the amortization calculator prints the full schedule.
PITI: the rest of the payment
Lenders usually collect more than principal and interest. The full payment is often called PITI:
- Principal and interest — the loan payment above.
- Taxes — property tax, typically collected monthly into an escrow account and paid by your servicer when due. Nationally, the median tax paid is about 0.89% of the median home value (Census ACS 2024), but rates vary widely by state and county — see property tax by state.
- Insurance — homeowners insurance, also usually paid through escrow.
Two more items may be added: mortgage insurance (PMI on conventional loans with less than 20% down, or MIP on FHA loans) and HOA dues, which are usually paid directly to the association. The mortgage calculator includes all of them.
Loan terms: 30 years, 15 years and in between
The 30-year fixed is the most common choice because it has the lowest payment. A 15-year loan has a higher payment but usually a lower rate and far less total interest. You can compare them directly with the 15 vs 30 year calculator.
Types of mortgage
- Conventional loans are not government-insured. Many follow Fannie Mae and Freddie Mac guidelines and allow down payments as low as 3%, with PMI below 20% down.
- FHA loans are insured by the Federal Housing Administration, allow 3.5% down with a credit score of 580 or higher, and charge upfront and annual mortgage insurance premiums. See the FHA loan calculator.
- VA loans (for eligible service members and veterans) and USDA loans (for eligible rural areas) can require no down payment.
The documents that matter
Within three business days of applying, lenders must give you a Loan Estimate — a standard three-page form that makes offers easy to compare. At least three business days before closing you receive a Closing Disclosure with the final terms. The CFPB publishes line-by-line explainers of both forms.
Key takeaways
- Your rate and term drive the principal-and-interest payment; taxes, insurance, mortgage insurance and HOA dues can add a lot on top.
- Early payments are mostly interest; extra principal payments early on have the biggest effect.
- Compare Loan Estimates from several lenders — small rate differences add up to large sums.
Sources
- Consumer Financial Protection Bureau, “Loan Estimate explainer”
- Consumer Financial Protection Bureau, “Closing Disclosure explainer”
- U.S. Census Bureau, American Community Survey 2024 1-year estimates, table B25103 (median real estate taxes paid) and table B25077 (median value, owner-occupied units)
- U.S. Department of Housing and Urban Development, Single Family Housing Policy Handbook 4000.1 (minimum required investment and credit score rules)
- Freddie Mac, “Understanding homebuying costs,” My Home by Freddie Mac (accessed September 2026)