A mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan. However, the word mortgage alone, in everyday usage, is most often used to mean mortgage loan.
A home buyer or builder can obtain financing (a loan) either to purchase or secure against the property from a financial institution, such as a bank, either directly or indirectly through intermediaries. Features of mortgage loans such as the size of the loan, maturity of the loan, interest rate, method of paying off the loan, and other characteristics can vary considerably.
Basic concepts and legal regulation
As with other types of loans, mortgages have an interest rate and are scheduled to amortize over a set period of time, typically 30 years. All types of real property can be, and usually are, secured with a mortgage and bear an interest rate that is supposed to reflect the lender’s risk.
Mortgage lending is the primary mechanism used in many countries to finance private ownership of residential and commercial property.
Mortgage loan types
There are many types of mortgages used worldwide, but several factors broadly define the characteristics of the mortgage. All of these may be subject to local regulation and legal requirements.
- Interest: interest may be fixed for the life of the loan or variable, and change at certain pre-defined periods; the interest rate can also, of course, be higher or lower.
- Term: mortgage loans generally have a maximum term, that is, the number of years after which an amortizing loan will be repaid. Some mortgage loans may have no amortization, or require full repayment of any remaining balance at a certain date, or even negative amortization.
- Payment amount and frequency: the amount paid per period and the frequency of payments; in some cases, the amount paid per period may change or the borrower may have the option to increase or decrease the amount paid.
- Prepayment: some types of mortgages may limit or restrict prepayment of all or a portion of the loan, or require payment of a penalty to the lender for prepayment.
The two basic types of amortized loans are the fixed rate mortgage (FRM) and adjustable-rate mortgage (ARM) (also known as a floating rate or variable rate mortgage). In many countries (such as the United States), floating rate mortgages are the norm and will simply be referred to as mortgages. Combinations of fixed and floating rate are also common, whereby a mortgage loan will have a fixed rate for some period, and vary after the end of that period.
- In a fixed rate mortgage, the interest rate, and hence periodic payment, remains fixed for the life (or term) of the loan. Therefore the payment is fixed, although ancillary costs (such as property taxes and insurance) can and do change. For a fixed rate mortgage, payments for principal and interest should not change over the life of the loan,
- In an adjustable rate mortgage, the interest rate is generally fixed for a period of time, after which it will periodically (for example, annually or monthly) adjust up or down to some market index. Adjustable rates transfer part of the interest rate risk from the lender to the borrower, and thus are widely used where fixed rate funding is difficult to obtain or prohibitively expensive. Since the risk is transferred to the borrower, the initial interest rate may be from 0.5% to 2% lower than the average 30-year fixed rate; the size of the price differential will be related to debt market conditions, including the yield curve.