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How US Mortgages Work: Down Payments, PMI, and Rate Types

A mortgage has more moving pieces than a single interest rate number. Here is how the main pieces actually fit together.

Down payment size determines whether you pay PMI

On a conventional loan, putting down less than 20% of the purchase price generally triggers private mortgage insurance (PMI), an extra monthly cost that protects the lender, not you, if you default. PMI is not permanent β€” lenders are generally required to cancel it once you reach 22% equity, and you can request removal yourself once you hit 20% equity.

Fixed-rate vs. adjustable-rate (ARM)

A fixed-rate mortgage locks the same interest rate for the entire loan term, so the principal-and-interest portion of the payment never changes. An adjustable-rate mortgage (ARM) starts with a lower introductory rate for a set period, then adjusts periodically based on market conditions, which can raise or lower the payment later.

15-year and 30-year terms are the most common

A 30-year term spreads payments out and lowers the monthly amount but costs more in total interest over the life of the loan. A 15-year term has a higher monthly payment but builds equity faster and pays far less total interest, assuming the same rate.

Closing costs typically run 2-5% of the loan amount

These one-time fees β€” covering things like loan origination, appraisal, title insurance, and recording fees β€” are paid at closing, on top of the down payment. On a $350,000 loan, that can mean roughly $7,000 to $17,500 due at closing.

Escrow accounts bundle taxes and insurance into your payment

Many lenders collect a portion of your annual property tax and homeowners insurance bill each month along with your mortgage payment, holding it in an escrow account and paying those bills on your behalf when they come due, so you are not hit with one large annual bill.

Credit score has a large effect on your rate

Borrowers with stronger credit typically qualify for meaningfully lower interest rates, and even a fraction-of-a-percent difference in rate can add up to tens of thousands of dollars in extra interest over a 30-year term.

Pre-approval is not the same as pre-qualification

Pre-qualification is a rough, informal estimate based on self-reported information. Pre-approval involves an actual credit check and document review by a lender, producing a more reliable number that sellers take more seriously when you make an offer.

The monthly payment has more parts than "principal and interest"

A typical mortgage payment is often described by the acronym PITI: principal, interest, taxes, and insurance. PMI, when it applies, adds a fifth component on top. Two loans with the same interest rate can still have noticeably different total monthly payments once taxes, insurance, and PMI are factored in.

Why ARMs can make sense for some buyers

Because an ARM's introductory rate is usually lower than a comparable fixed rate, it can reduce payments during the initial fixed period, which suits buyers who expect to sell or refinance before the rate adjusts. The risk is that if you stay past the introductory period and rates have risen, your payment can increase meaningfully.

Frequently Asked Questions

Can I avoid PMI without a 20% down payment?

Some options exist, such as certain loan programs, lender-paid mortgage insurance structured into a slightly higher rate, or a piggyback second loan, but each comes with its own tradeoffs, so comparing the total cost of each approach against simply paying PMI is worth doing before choosing.

Is a lower interest rate always the better loan?

Not necessarily β€” a loan with a lower rate but higher closing costs or lender fees, sometimes called "points" paid upfront to buy down the rate, is not automatically cheaper overall. Comparing the full cost over the time you actually expect to keep the loan is more reliable than comparing the rate alone.

What happens if my home's value drops after I buy?

Your loan balance and payment do not change based on your home's market value β€” a mortgage is a fixed obligation regardless of price swings. A drop in value mainly affects your equity and could complicate refinancing or selling until the value recovers or the balance is paid down.