Mortgages are loans taken out to buy a home. They allow you to make real estate purchases without having to pay the whole tag price up front. Mortgages are “long-term, low-interest” loans, so they are usually worth considering as opposed to short-term, high-interest consumer debt. Institutions that sell mortgages can afford to offer low-interest loans (around 4% on average) because the house is used as collateral. If the buyer stops paying her mortgage, the lender can foreclose the house and take back possession of it. Remember, collateral is an asset that protects the money that the lender lends to a borrower. That is why mortgages are risky if you don’t have a steady income, as you run a risk of ruining your credit or even losing your home.

There are two types of mortgages. The first is fixed-rate mortgage (FRM), where the interest rate remains the same for the entire duration of the loan. A fixed-rate mortgage offers the borrower the peace of mind that comes with always knowing how much she will have to pay. The second kind of mortgages are adjustable-rate mortgages (ARM). These are mortgages in which the interest applied changes throughout the duration of the loan. With adjustable-rate mortgages, you run the risk of having to pay more at a time when you have less cash flow. However, adjustable-rate mortgages usually have lower average rates than fixed-rate mortgages. Usually, the initial interest rate is fixed for some time, and then it changes every few months or years depending on several factors.

Some important terms to know when dealing with mortgage loans are margin, PMI, equity, and balloon payments. Margin refers to the “additional percentage points” that financial institutions typically add onto the existing federal interest rates when offering adjustable-rate mortgages (ARMs). There are additional costs that a home buyer incurs that are not covered within the purchase price of the home. These costs are referred to as “closing costs”, and they include: taxes, title insurance, legal fees, and escrow payments. They are typically 2% to 5% of the home’s purchase price. Financial institutions that provide mortgages take on a risk because the homebuyer may default on payments. Therefore, they sometimes have the homebuyer take out private mortgage insurance to protect themselves. A potential home buyer with a low down payment is likely to be required to pay for the institution’s PMI. The insurance protects the institution against loss incurred by probable defaulting. Equity is the value of a property owned by the buyer. It is the value of an asset minus any liabilities associated with that asset. It can be increased in a number of ways, such as making mortgage payments which reduces the liabilities, and making improvements to the property which increases the value of the asset. Taking more loans not only increases debt and liabilities but also digs into the person’s equity on the property they hold. When a mortgage term is short (less than 10 years), financial institutions may require you to pay interest in smaller installments first and then clear the actual mortgage loan in one big payment at the end of the term. This payment is known as a “balloon payment.” This payment plan is usually better for those with good credit and a high income.

If you are already a homeowner with a decent amount of equity built up on your home, you may take out another loan against your home’s equity (i.e. having your home as collateral for a second time). This is known as a “second mortgage”, and these tend to attract higher interest rates. A borrower who takes out a second mortgage is piling onto the debt they already have. More debt means they will be more likely to default on their mortgages and if they do, the house can be repossessed by the provider of the first mortgage, not the second. One way that the U.S. Government encourages home ownership is by backing mortgages through government entities. In doing this, the federal government takes on the risk of defaulting and covers the losses incurred for the seller in the event that it happens. This is an ideal option for first-time and low-income buyers. The federal government takes on the risk of default, backs the mortgage through government entities, and covers the losses incurred in the event that default happens.

One unique mortgage is a reverse mortgage which is extended to seniors and retirees only. It works by giving homeowners a loan against their home’s equity. This loan can be withdrawn in a lump sum but will require set monthly payments. If the homeowner doesn’t make monthly payments, the creditor has a claim on the property (up to the amount owed) when the borrower passes away.

A combination mortgage is another special type of mortgage which essentially combines two (or more) different loans. It is normally taken out by people who want to avoid PMI. For example, if you cannot afford the 20% down payment on a home, you can take a loan to cover only the down payment and then take out another loan for the remaining 80% of the home’s value.

Cindy and Mark finally settled on a $350,000 house they both like. The bank would like them to contribute $70,000, or 20%, as part of their down payment. However, they only have $35,000, or 10%. Cindy and Mark know their stuff though, and want to avoid PMI at all costs, so they take out a separate $35,000 loan so they can cover the 20% down payment and avoid PMI. Crisis averted!

In addition, VA loans are government-backed mortgages offered by the Department of Veterans Affairs for active duty, veteran, and reserve members of the U.S. military. Home buyers in this category do not have to make any down payments for homes. USDA loans are government-backed loans offered by the United States Department of Agriculture (USDA) to encourage rural home ownership. They offer very low down payment loans to families that live and work in these areas. FHA loans are government-backed, low-interest loans offered by the Federal Housing Administration. They are best suited for first-time home buyers and people with poor credit scores. They can be used to purchase any type of home.

Also, the Indian Home Loan Guarantee Program is sponsored by the Department of Housing and Urban Development (HUD) and provides loans to lower-income members of the Native American, Hawaiian, and Native Alaskan communities. Also state and local programs sometimes offer policies or projects aimed at revitalizing abandoned areas and homes. These are ideal for people of low income or those who are struggling to come up with down payments.