What is a mortgage? How home loans work, in plain English

A mortgage is a loan used to buy property, where the property itself serves as security for the lender. If the borrower stops paying, the lender can ultimately sell the home to recover the money. That security is why mortgages usually carry lower interest rates and longer terms than other kinds of borrowing.

For most people a mortgage is the largest financial commitment they will ever make, so it pays to understand the moving parts before speaking to a bank. This guide explains how a mortgage works, the key terms and the costs people often overlook. It is general information, not financial advice; your own situation and local rules matter.

How does a mortgage work?

You agree to borrow a sum from a lender, typically a bank or building society, to cover the part of the purchase price you cannot pay yourself. The lender registers a legal charge over the property. In Germany this is usually a land charge (Grundschuld) entered in the land register.

You then repay the loan over many years, often 20 to 30 or more, in regular monthly instalments. Each payment is split between interest, which is the lender's fee for lending, and repayment of the amount borrowed, known as the principal. When the principal reaches zero, the charge is removed and the home is fully yours.

Repayment, interest and the amortization schedule

The most common structure is the repayment or annuity mortgage. Your monthly payment stays the same for an agreed period, but its make-up changes. At first most of it goes on interest, because the outstanding balance is large. Over time the interest portion shrinks and more of each payment reduces the debt.

An amortization schedule shows this split month by month. It is worth asking for one, because it reveals how much you will still owe when a fixed-rate period ends and how much the loan costs in total.

In Germany borrowers usually choose an initial repayment rate (anfängliche Tilgung) as a percentage of the loan. A higher rate raises the monthly payment but clears the debt much faster and cuts total interest. Interest-only mortgages, where you repay the principal at the end, exist in some countries but carry more risk because the debt does not shrink.

Look beyond the headline interest rate: flexibility and total cost matter just as much.

Fixed vs variable rate mortgages

With a fixed rate, the interest rate is locked for a set period, which might be a few years in some countries or ten, fifteen or more in Germany (Sollzinsbindung). You know exactly what you will pay, which makes budgeting easier, but you do not benefit if market rates fall.

With a variable or tracker rate, the interest moves with a reference rate. Payments can fall when rates drop and rise sharply when they climb. Variable loans often allow more flexibility to repay early.

When a fixed period ends, you need a follow-on arrangement. You can stay with your lender, switch to another one or repay the remaining balance. The rate you get then depends on the market at that time, which is known as interest rate risk. Some borrowers lock in a future rate in advance with a forward loan.

How much deposit do you need?

The deposit, or equity, is the part of the price you pay from your own money. Lenders measure risk with the loan-to-value ratio (LTV): the loan as a percentage of the property's value. A lower LTV usually earns a better interest rate.

Some lenders will finance close to the full price, but that means higher rates and a larger debt if property values fall. A common guideline is to bring enough savings to cover at least the purchase costs plus a meaningful share of the price.

The extra costs of buying a home

The price on the listing is not the whole bill. In Germany, purchase costs (Kaufnebenkosten) can add a significant percentage on top and are rarely financed by lenders.

• Property transfer tax (Grunderwerbsteuer), whose rate depends on the federal state
• Notary and land registry fees
• Estate agent commission, where an agent is involved
• Valuation, survey or arrangement fees charged by some lenders
• Building or home insurance, often required by the lender
• Moving costs and a reserve for repairs

How much mortgage can you afford?

Lenders look at your income, job stability, existing debts, household spending and credit record. In Germany they also check your SCHUFA credit file. They then calculate how much you can repay while still covering living costs.

Do your own maths first. A widely used rule of thumb is that housing costs should stay around a third of net household income, but the right figure depends on your other commitments. Leave room for maintenance, rising energy costs and a possible rate increase after the fixed period. Keep an emergency fund separate from your deposit.

Paying off a mortgage early

Many loans allow special repayments (Sondertilgungen) up to an agreed amount each year without penalty. Negotiate this before you sign, because it adds flexibility for bonuses or inheritances.

Ending a fixed-rate loan early outside these options can trigger an early repayment charge (Vorfälligkeitsentschädigung) that compensates the lender for lost interest. In Germany borrowers have a legal right to give notice on a fixed-rate loan ten years after full payout, with six months' notice, even if the fixed period is longer.

Frequently asked questions

Once you understand what a mortgage is, the offers from different lenders become far easier to compare. Look beyond the headline interest rate: check the fixed period, the repayment rate, the flexibility for extra payments and the total cost over the term. Get several quotes, read the European Standardised Information Sheet or its local equivalent, and consider independent advice before signing.

How we research: Guides are written from established sources and checked for accuracy. They are general information, not professional advice.