ArtsAutosBooksBusinessEducationEntertainmentFamilyFashionFoodGamesGenderHealthHolidaysHomeHubPagesPersonal FinancePetsPoliticsReligionSportsTechnologyTravel

How a mortgage works

Updated on July 23, 2012
Terraces in Glebe, suburban Sydney, Australia
Terraces in Glebe, suburban Sydney, Australia | Source

The basics of mortgages

A mortgage is a loan from a bank, building society, savings and loans or other financial institution which is secured on real estate, i.e. on residential or commercial property. That means that if you fail to pay your mortgage the bank or whoever holds the mortgage can repossess (claim ownership of) your property.

Most people who buy a residential property to live in do so with a mortgage. Many investors who buy property to let it out also use a mortgage to do so.

For most mortgages the bank charges interest on the outstanding amount of loan until it is repaid. An exception to this is Islamic mortgages, because Islam forbids the charging of interest. Islamic mortgages are set up in a slightly different legal structure but the overall effect is similar.

For most people a mortgage is the largest and most significant financial product they will take out in their entire lives, with the possible exception of a pension. So it makes sense to understand something about how they work.

Equity, negative equity and loan to value

Mortgage lenders will put a limit on how much you can borrow. This is sometimes expressed as a percentage, the loan to value. This is the amount of the loan divided by the total value of the property.

The mortgage company will usually charge you for a mortgage valuation which they will use to assess the value of the property.

Mortgage lenders will often have different deals available for people with different levels of loan to value. Generally the lower the loan to value the less risk you are to the mortgage lender so they will charge you a lower rate.

If your house is worth $100,000 and you have a mortgage for $90,000 then your loan to value is 90%. The $10,000 excess value of the house over your loan amount is called your equity. If your outstanding mortgage debt is greater than the value of your house you are said to be in negative equity.

In some countries (like the USA) mortgage debt is what is called "non-recourse". That means that you can give the house back to the mortgage company and you don't owe them another cent, even if you are in negative equity.

In other countries (like the UK) mortgage debt is "full recourse". That means that if you are in negative equity, even if you give your house to the lender you will still owe them the difference.

Repayment or Interest Only

The term of a mortgage is how long it lasts, that is the length of time that you have borrowed the money for. At the end of the term all the money must have been repayed.

In broad terms there are two choices for repaying a mortgage.

1. A repayment mortgage - this is where you pay off the loan a little bit at a time over the term of the mortgage.

2. An interest only mortgage - this is where you only pay the interest every month but then repay the whole of the mortgage at the end.

For an interest only mortgage you should have some other savings or investment building up so that you can pay the mortgage at the end of the term. Some people plan to sell their house or remortgage at the end of the term but that is risky as there is no guarantee you will be able to do so.

In the past many people took our endowment assurance policies as an investment to pay off their mortgages, sometimes these were referred to together with the interest only mortgage as "endowment mortgages".

A mortgage example

It is probably clearest to see what is happening with an example.

Let's say that Joe takes out a repayment mortgage for $100,000. His friend Christine takes out an interest only mortgage for $100,000. They both are being charged 5% per year.

Christine will pay 5% x $100,000 = $5,000 a year, which is $417 a month.

The maths is a bit more complicated for Joe but he will pay $578 a month. As you can tell most of this ($417) is interest at the start, but as time goes on the outstanding loan amount will fall and less and less interest will be charged.

After one year Christine will still owe $100,00 but Joe will only owe $97,905. He will have paid off $2,095.

There's a lot more to find out...

There is a lot more to find out about mortgages - mortgage companies offer lots of different products with different interest rates and different guarantees and offers and charges. I also haven't discussed Islamic mortgages as they work in a different way.

There are plenty of resources on the internet for further research. You may also like to speak to a professional advisor where you are who will be able to advise you about products that will fit your personal circumstances.


    0 of 8192 characters used
    Post Comment

    No comments yet.


    This website uses cookies

    As a user in the EEA, your approval is needed on a few things. To provide a better website experience, uses cookies (and other similar technologies) and may collect, process, and share personal data. Please choose which areas of our service you consent to our doing so.

    For more information on managing or withdrawing consents and how we handle data, visit our Privacy Policy at:

    Show Details
    HubPages Device IDThis is used to identify particular browsers or devices when the access the service, and is used for security reasons.
    LoginThis is necessary to sign in to the HubPages Service.
    Google RecaptchaThis is used to prevent bots and spam. (Privacy Policy)
    AkismetThis is used to detect comment spam. (Privacy Policy)
    HubPages Google AnalyticsThis is used to provide data on traffic to our website, all personally identifyable data is anonymized. (Privacy Policy)
    HubPages Traffic PixelThis is used to collect data on traffic to articles and other pages on our site. Unless you are signed in to a HubPages account, all personally identifiable information is anonymized.
    Amazon Web ServicesThis is a cloud services platform that we used to host our service. (Privacy Policy)
    CloudflareThis is a cloud CDN service that we use to efficiently deliver files required for our service to operate such as javascript, cascading style sheets, images, and videos. (Privacy Policy)
    Google Hosted LibrariesJavascript software libraries such as jQuery are loaded at endpoints on the or domains, for performance and efficiency reasons. (Privacy Policy)
    Google Custom SearchThis is feature allows you to search the site. (Privacy Policy)
    Google MapsSome articles have Google Maps embedded in them. (Privacy Policy)
    Google ChartsThis is used to display charts and graphs on articles and the author center. (Privacy Policy)
    Google AdSense Host APIThis service allows you to sign up for or associate a Google AdSense account with HubPages, so that you can earn money from ads on your articles. No data is shared unless you engage with this feature. (Privacy Policy)
    Google YouTubeSome articles have YouTube videos embedded in them. (Privacy Policy)
    VimeoSome articles have Vimeo videos embedded in them. (Privacy Policy)
    PaypalThis is used for a registered author who enrolls in the HubPages Earnings program and requests to be paid via PayPal. No data is shared with Paypal unless you engage with this feature. (Privacy Policy)
    Facebook LoginYou can use this to streamline signing up for, or signing in to your Hubpages account. No data is shared with Facebook unless you engage with this feature. (Privacy Policy)
    MavenThis supports the Maven widget and search functionality. (Privacy Policy)
    Google AdSenseThis is an ad network. (Privacy Policy)
    Google DoubleClickGoogle provides ad serving technology and runs an ad network. (Privacy Policy)
    Index ExchangeThis is an ad network. (Privacy Policy)
    SovrnThis is an ad network. (Privacy Policy)
    Facebook AdsThis is an ad network. (Privacy Policy)
    Amazon Unified Ad MarketplaceThis is an ad network. (Privacy Policy)
    AppNexusThis is an ad network. (Privacy Policy)
    OpenxThis is an ad network. (Privacy Policy)
    Rubicon ProjectThis is an ad network. (Privacy Policy)
    TripleLiftThis is an ad network. (Privacy Policy)
    Say MediaWe partner with Say Media to deliver ad campaigns on our sites. (Privacy Policy)
    Remarketing PixelsWe may use remarketing pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to advertise the HubPages Service to people that have visited our sites.
    Conversion Tracking PixelsWe may use conversion tracking pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to identify when an advertisement has successfully resulted in the desired action, such as signing up for the HubPages Service or publishing an article on the HubPages Service.
    Author Google AnalyticsThis is used to provide traffic data and reports to the authors of articles on the HubPages Service. (Privacy Policy)
    ComscoreComScore is a media measurement and analytics company providing marketing data and analytics to enterprises, media and advertising agencies, and publishers. Non-consent will result in ComScore only processing obfuscated personal data. (Privacy Policy)
    Amazon Tracking PixelSome articles display amazon products as part of the Amazon Affiliate program, this pixel provides traffic statistics for those products (Privacy Policy)
    ClickscoThis is a data management platform studying reader behavior (Privacy Policy)