April 18th, 2025
If you’ve ever dreamed about owning your own home, chances are you’ve come across the term “mortgage.” But what exactly is a mortgage, and how does it work?
In this guide, we’ll break it down in simple terms using a real-life example that makes the concept easy to understand—perfect for first-time homebuyers or anyone brushing up on the basics of personal finance.
A mortgage is a loan provided by a bank or financial institution that helps you finance the purchase of a home. Because most people don’t have hundreds of thousands of dollars sitting in the bank, a mortgage makes it possible to buy a home now and pay it off over time.
What makes a mortgage different from other loans is that the home itself is used as collateral. This means if you don’t keep up with your payments, the lender can take ownership of your home through a legal process called foreclosure.
Let’s say Mark and Lisa are newlyweds looking to buy their first home. After a long search, they find their dream house, but it comes with a hefty price tag—$500,000, which is more than they have saved.
To bridge the gap, they visit a bank and apply for a mortgage. The lender first asks them how much money they can pay upfront, also known as a down payment.
A down payment is the portion of the home’s price you pay out of pocket. While 20% is often suggested as a standard amount, down payment requirements can vary depending on the lender and the type of loan.
Mark and Lisa decide to put down $100,000—20% of the home’s value. That means they’ll need to borrow the remaining $400,000 through a mortgage.
Once their application is reviewed—including their credit history and income—the bank approves a $400,000 mortgage at a fixed interest rate of 5%, with a five-year term and a 40-year amortization period.
Let’s break that down:
The 5% fixed rate means Mark and Lisa will pay the same interest rate for the first five years of the loan, regardless of how the market changes. This provides predictable monthly payments, which is why fixed-rate mortgages are considered more stable—especially for first-time buyers.
Alternatively, they could have chosen a variable (or floating) rate, which fluctuates with the market. Variable rates often start lower but carry more risk if interest rates rise.
The amortization period is the total time it will take to repay the entire loan—in this case, 40 years. Each monthly payment they make will include a portion of interest and a portion that reduces the loan balance (the principal). At the end of 40 years, assuming all payments are made on time, Mark and Lisa will fully own their home.
With every mortgage payment, Mark and Lisa are doing more than just paying off a loan—they’re building equity. Equity is the portion of the home they truly own, and it increases each time they make a payment.
Instead of paying rent to a landlord, they’re investing in an asset. Over time, as they pay down the mortgage and the home (hopefully) increases in value, their equity grows.
Let’s imagine Mark and Lisa receive an offer to sell their home for $600,000 just one day after buying it. If they accept, they’ll pay back the $400,000 mortgage to the bank and keep the remaining $200,000. Because they originally invested $100,000 as a down payment, they’ve now doubled their money.
This example highlights one of the potential financial benefits of homeownership: appreciation. While the housing market does fluctuate, owning a home can be a long-term way to build wealth.
A mortgage isn’t just a financial tool—it’s a pathway to homeownership and long-term security. Understanding how it works, from the down payment to the amortization schedule, helps you make smarter choices and avoid surprises.
If you’re thinking about purchasing a home in Denver or anywhere in Colorado, Miranda Mortgage is here to help. We offer educational guidance and a range of loan options tailored to your needs.
Have questions about mortgage types, down payment options, or how to qualify? Let’s talk.
Call us at 303.520.1786 or email Naiely at Naiely@BarrettFinancial.com to schedule a free consultation.
