A mortgage is a loan secured by property or real estate. A mortgage is usually paid back with monthly payments that usually include principal, interest, insurance, and taxes. The principal is the amount of the loan, and the interest is what it costs you to borrow the money for the month. The taxes are a percentage of the value of the property and remitted to your local government, while the insurance covers the mortgage amount in case of default by the borrower as well as property loss from hazards. The tax and insurance monies may be collected and held in escrow to be paid annually.

How do banks decide how much mortgage money you can borrow? They base their decision of the amount of a mortgage on their estimate of your ability to repay the loan. This estimation is based on your income, available cash, debt, and your credit history. The amount of money banks will loan is usually in the neighborhood of two to four times your annual salary.

When applying for a mortgage your debt to income ratio can be a limiting factor. Banks first look at your front-end ratio or how much of your income will be devoted to paying your mortgage. About 28% of your annual income is the amount most banks feel a person can afford to pay for a mortgage, and this of course would cover the amount of the principle, interest, and any escrow payments. You can calculate this yourself by taking your annual salary and multiply by .28 and then divide by 12, this will give you an estimate of the maximum mortgage amount you could be offered.

The back-end ratio will also be taken into consideration as well. This is the amount of your gross income is required to pay all your debts, which could include car payments, credit card payments, personal loans, student loans, alimony, and child support. The amount of your total payments should not exceed 36% of your gross income. This can also be calculated by taking your annual salary and multiplying by .36 and dividing by 12. This will give you your maximum allowable amount of debt.

Mortgages come in two types fixed-rate and adjustable-rate mortgages or ARM's.With a fixed-rate loan you pay the same interest rate for the life of the mortgage and the payments could last for 15, 20, or 30 years usually. Keep in mind that the shorter the life of the mortgage loan the less interest you will have to pay, but your payment amount will be larger.

Fixed-rate mortgages make planning easier (because the payment amount doesn't change) and are simpler to understand. If however, you wanted to take advantage of falling interest rates you would have to refinance which would require additional paperwork as well as refinancing fees.

An adjustable-rate mortgage or ARM is simply a mortgage whose interest rate can go up or down throughout the life of the mortgage. This of course will make your payment go up or down as well and is influenced by various economic factors. Although ARM's interest rates usually start out lower than a fixed-rate loan they can of course surpass the fixed-rate interest amount when they adjust which usually happens once a year.

ARM's have the additional advantage of allowing you to finance a larger mortgage, which could be advantages if you know your income will be increasing or if you plan on selling the home within five years or so. Also if interest rates fall you will not be required to refinance as it will happen automatically, and you will enjoy the new lower rate (and a lower payment amount of course.)

However with an ARM mortgage your interest rate and of course your payment can also increase (sometimes significantly) if the market rates (ARM's are usually based off the market rates) goes up.

Although the current economic situation has tightened up the lending practices of most lenders, keep in mind that real estate agents as well as banks make more money for larger loans. Take your lifestyle and budget into consideration when you determine how much mortgage payment you are willing to take on. Also remember with home ownership comes other costs such as maintenance, repairs, and higher utility bills.

There are many mortgage calculators available online to give you an idea of how much you can borrow for a mortgage. To find out for certain you will need to contact a lender or a mortgage broker (they can help you find the very best deal out there) to get a quote.

A mortgage is the largest loan most people will commit to in their lifetime, and deserves due consideration and care. Good luck and I hope you are able to get the mortgage loan you need to buy the home you want!

This article is for informational purposes only and you should always consult a professional advisor before making any financial decisions.