Learn About Debt
Understanding debt is the first step to making better financial decisions.
What is Debt?
Debt is money you borrow and promise to pay back, usually with interest. It's a tool that lets you buy things now and pay for them over time.
When you take on debt, you're making a bet: that having the money now is worth more than the extra cost (interest) you'll pay later.
For a home, this often makes sense. You get to live in the house while you pay for it, and homes typically appreciate in value.
How Interest Works
Interest is the cost of borrowing money. It's calculated as a percentage of what you owe.
With a mortgage, most of your early payments go toward interest, not principal. This is because interest is calculated on the remaining balance, which is highest at the start.
Over time, as you pay down the principal, more of each payment goes toward reducing what you owe rather than paying interest.
Good vs Bad Debt
Good debt helps you build wealth or increase your earning potential. Mortgages and student loans often fall into this category.
Bad debt is used for things that lose value quickly or don't generate income. Credit card debt for consumer goods is a common example.
The key difference: good debt is an investment in your future, while bad debt is paying extra for past consumption.
Making Smart Decisions
Before taking on debt, ask yourself:
- Can I afford the monthly payments comfortably?
- What's the total cost including interest?
- Are there better alternatives?
- How long will I keep this debt?
- What happens if my situation changes?
Use our calculators to run the numbers and see the real cost of different debt scenarios. Knowledge is power when it comes to financial decisions.
Common Terms You Should Know
Navigate through these essential mortgage and debt terms to build your financial vocabulary.
Amortization
The process of paying off a loan over time through regular payments that cover both principal and interest.
APR (Annual Percentage Rate)
The yearly cost of a loan including interest and fees, expressed as a percentage.
ARM (Adjustable-Rate Mortgage)
A mortgage with an interest rate that can change periodically based on market conditions.
Appraisal
A professional assessment of a property's market value, required by lenders before approving a mortgage.
Closing Costs
Fees and expenses paid at the closing of a real estate transaction, typically 2-5% of the purchase price.
Conventional Loan
A mortgage not insured or guaranteed by the federal government.
Debt-to-Income Ratio (DTI)
The percentage of your monthly income that goes toward debt payments. Lenders use this to assess loan eligibility.
Down Payment
The upfront cash payment made when purchasing a home, typically 3-20% of the purchase price.
Equity
The difference between your home's current market value and the amount you owe on your mortgage.
Escrow
An account where funds are held by a third party to pay property taxes and insurance on behalf of the homeowner.
FHA Loan
A mortgage insured by the Federal Housing Administration, allowing lower down payments and credit scores.
Fixed-Rate Mortgage
A mortgage with an interest rate that remains constant throughout the life of the loan.
HOA (Homeowners Association)
An organization that makes and enforces rules for a community, typically charging monthly or annual fees.
Interest
The cost of borrowing money, calculated as a percentage of the loan amount.
Loan-to-Value Ratio (LTV)
The ratio of the loan amount to the property's value, expressed as a percentage.
Mortgage Points
Upfront fees paid to the lender to reduce your interest rate. One point equals 1% of the loan amount.
Mortgage Recast
Recalculating your monthly payment after making a large principal payment, without refinancing.
PITI
Principal, Interest, Taxes, and Insurance - the four components of a typical monthly mortgage payment.
PMI (Private Mortgage Insurance)
Insurance required by lenders when down payment is less than 20%, protecting the lender if you default.
Pre-approval
A lender's conditional commitment to lend you a specific amount based on verified financial information.
Pre-qualification
An estimate of how much you can borrow based on self-reported financial information.
Principal
The original amount of money borrowed, not including interest.
Refinance
Replacing your current mortgage with a new one, typically to get a better interest rate or change loan terms.
Term
The length of time you have to repay a loan, commonly 15 or 30 years for mortgages.
Title
Legal ownership of a property, transferred from seller to buyer at closing.
Underwriting
The process lenders use to assess the risk of lending to you and determine loan approval.
VA Loan
A mortgage guaranteed by the Department of Veterans Affairs, available to eligible veterans and service members.
Appreciation
The increase in a property's value over time due to market conditions.
Balloon Payment
A large, lump-sum payment due at the end of a loan term.
Cap
A limit on how much an ARM's interest rate can increase, either per adjustment period or over the loan's lifetime.
Cash-Out Refinance
Refinancing for more than you owe and taking the difference in cash.
Conforming Loan
A mortgage that meets the standards set by Fannie Mae and Freddie Mac, with loan limits that vary by location.
Contingency
A condition that must be met for a real estate contract to be binding, such as passing inspection.
Credit Score
A numerical representation of your creditworthiness, typically ranging from 300 to 850.
Deed
A legal document that transfers property ownership from seller to buyer.
Default
Failure to make required loan payments, which can lead to foreclosure.
Depreciation
A decrease in property value over time.
Earnest Money
A deposit made to show you're serious about buying a home, typically 1-3% of the purchase price.
Forbearance
A temporary postponement of mortgage payments granted by the lender during financial hardship.
Foreclosure
The legal process by which a lender takes possession of a property due to the borrower's failure to pay.
Grace Period
A period after the payment due date during which you can make a payment without penalty.
Home Inspection
A thorough examination of a property's condition by a professional inspector before purchase.
Jumbo Loan
A mortgage that exceeds conforming loan limits, typically requiring higher credit scores and larger down payments.
Lien
A legal claim against a property, often used to secure payment of a debt.
Mortgage Broker
A professional who connects borrowers with lenders and helps find the best loan terms.
Origination Fee
A fee charged by lenders for processing a new loan application, typically 0.5-1% of the loan amount.
Rate Lock
An agreement that guarantees a specific interest rate for a set period, usually 30-60 days.
Second Mortgage
An additional loan taken out on a property that already has a mortgage, such as a home equity loan.
Short Sale
Selling a property for less than the amount owed on the mortgage, with lender approval.
Title Insurance
Insurance that protects against losses from defects in the title or ownership disputes.
Yield Spread Premium
Compensation paid to a mortgage broker for securing a loan with an interest rate higher than the lender's minimum.