A mortgage is a legal contract that describes the terms of the loan obtained to buy a piece of property. It stipulates that if you don't meet the repayment terms of the loan, the lender can take your property and sell it to get his money back. This process is known as foreclosure.

Principal and Interest

Mortgage payments are divided between principal (the amount you borrowed), and interest (the cost of borrowing the money). Each month a little bit more gets applied to the principal balance (very little!). On a traditional thirty-year mortgage, the payments for the first twenty years or so will be more interest than principal. For example, on a thirty-year $100,000 mortgage at 7 percent interest, your payments the first year would total $7,983, of which $6,967 would be for interest and only $1,015 for principal. At the end of the year you would still owe a balance of $98,985. Over the life of the thirty-year mortgage, you'd repay the $100,000 you borrowed plus $139,509 in interest, for a total of $239,509. (Chapter 12 discusses ways you can cut tens of thousands of dollars from your interest costs.)

Private Mortgage Insurance

If it weren't for private mortgage insurance (PMI), which protects the lender in case you're unable to make the payments on your loan, you might not be able to buy a house for many years. Most lenders require a 20 percent down payment, so on a $100,000 loan, you'd be required to come up with approximately $25,000 for the down payment and closing costs. PMI, which ranges between $40 and $100 per month, helps you buy a house with as little as 5 to 10 percent down and is folded into your loan payments.

Under federal law, your lender is required to automatically terminate PMI when your equity reaches 22 percent of the original appraised value of your home. To calculate what percent equity you have in your home, divide your loan balance by the appraised value and deduct this number from 100.

If you bought your home after 1999, your lender must terminate your PMI when you reach 20 percent equity, if you request it. Some businesses offer a service to help you get your PMI dropped, but don't waste your money. Just call your lender and ask if you're paying PMI and if so, when it can be canceled. Then be sure to call again when that time arrives. If you have an FHA or VA loan, PMI isn't required because the federal government has already agreed to protect the lender if you default on your loan.