A mortgage loan is a loan secured by real property through the use of a mortgage (a legal instrument). 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 secured 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.According to Anglo-American property law, a mortgage occurs when an owner (usually of a fee simple interest in realty) pledges his interest as security or collateral for a loan. Therefore, a mortgage is an encumbrance on property just as an easement would be, but because most mortgages occur as a condition for new loan money, the word mortgage has become the generic term for a loan secured by such real property.
As with other types of loans, mortgages have an interest rate and are scheduled to amortize over a set period of time; typically 25, 30 and in recent years 40 years. All types of real property can, and usually are, secured with a mortgage and bear an interest rate that is supposed to reflect the lender's risk.
Governments usually regulate many aspects of mortgage lending, either directly (through legal requirements, for example) or indirectly (through regulation of the participants or the financial markets, such as the banking industry), and often through state intervention (direct lending by the government, by state-owned banks, or sponsorship of various entities). Other aspects that define a specific mortgage market may be regional, historical, or driven by specific characteristics of the legal or financial system.
Mortgage loans are generally structured as long-term loans, the periodic payments for which are similar to an annuity and calculated according to the time value of money formula. The most basic arrangement would require a fixed monthly payment over a period of ten to thirty years, depending on local conditions. Over this period the principal component of the loan (the original loan) would be slowly paid down through amortization. In practice, many variants are possible and common worldwide and within each country.
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, floating rate mortgages are the norm and will simply be referred to as mortgages; in the United States, fixed rate mortgages are typically considered "standard." 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. In the Canada the term is usually up to 40 years (25 and 30 being the most common), although longer terms may be offered in certain circumstances. For a fixed rate mortgage, payments for principal and interest should not change over the life of the loan, although ancillary costs (such as property taxes and insurance) can and do change.
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.
Common indices in the Canada include the Prime Rate, the London Interbank Offered Rate (LIBOR), and the Treasury Index ("T-Bill"); other indices are in use but are less popular. 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.
