How Mortgages Work: Fixed vs Adjustable, FHA, VA and Refinancing

A mortgage splits a home purchase into a monthly payment. You put down a percentage of the price (3% to 20% or more) and borrow the rest. Each payment covers interest — the lender's charge — and principal, which reduces what you owe. Early on, most goes to interest and little to principal (amortization); as the balance shrinks, the split flips.

The home is the collateral, which is what makes mortgage rates lower than almost any other consumer borrowing — and what gives the lender the right to foreclose. Property taxes and homeowners insurance are often bundled in and held in escrow, so the monthly figure usually exceeds principal and interest alone.

A fixed-rate mortgage locks the same rate for the entire term, so the principal-and-interest payment never changes — it trades a slightly higher starting rate for decades of certainty, which is why the 30-year fixed is most buyers' default.

An adjustable-rate mortgage (ARM) starts with a lower fixed rate for an intro period (commonly 5, 7, or 10 years), then adjusts periodically against a market index — a 5/1 ARM is fixed for five years, then adjusts annually. An ARM can save money if you expect to sell or refinance before the adjustment, but carries the risk of a higher payment later.

Beyond the rate, mortgages differ by program:

• Conventional: the standard loan, not government-backed. Strong credit and a larger down payment earn the best terms, and under 20% down typically means private mortgage insurance until you build equity.
• FHA: insured by the Federal Housing Administration, with lower credit and down-payment bars — the trade-off is mortgage insurance that can last the life of the loan.
• VA: for eligible veterans and service members, often with no down payment and no monthly mortgage insurance.
• Jumbo: for amounts above conforming limits, with stricter credit and reserve requirements.

A rate-and-term refinance swaps your loan for one with a lower rate or a different length; a cash-out refinance borrows more than you owe and returns the difference in cash. The math hinges on the new rate versus your current one and the closing costs.

A common test is the break-even point: divide the closing costs by the monthly savings to see how many months until you come out ahead. Stay in the home past that point and refinancing usually pays off; move sooner and it may not.