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.

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 30 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.

Mortgage lending is the primary mechanism used in many countries to finance private ownership of residential property. For commercial mortgages see the separate article. Although the terminology and precise forms will differ from country to country, the basic components tend to be similar:

Property: the physical residence being financed. The exact form of ownership will vary from country to country, and may restrict the types of lending that are possible.
Mortgage: the security created on the property by the lender, which will usually include certain restrictions on the use or disposal of the property (such as paying any outstanding debt before selling the property).
Borrower: the person borrowing who either has or is creating an ownership interest in the property.
Lender: any lender, but usually a bank or other financial institution.
Principal: the original size of the loan, which may or may not include certain other costs; as any principal is repaid, the principal will go down in size.
Interest: a financial charge for use of the lender's money.
Foreclosure or repossession: the possibility that the lender has to foreclose, repossess or seize the property under certain circumstances is essential to a mortgage loan; without this aspect, the loan is arguably no different from any other type of loan.
Many other specific characteristics are common to many markets, but the above are the essential features. 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 formulae. 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.

Lenders provide funds against property to earn interest income, and generally borrow these funds themselves (for example, by taking deposits or issuing bonds). The price at which the lenders borrow money therefore affects the cost of borrowing. Lenders may also, in many countries, sell the mortgage loan to other parties who are interested in receiving the stream of cash payments from the borrower, often in the form of a security (by means of a securitization). In the United States, the largest firms securitizing loans are Fannie Mae and Freddie Mac, which are government sponsored enterprises.

Mortgage lending will also take into account the (perceived) riskiness of the mortgage loan, that is, the likelihood that the funds will be repaid (usually considered a function of the creditworthiness of the borrower); that if they are not repaid, the lender will be able to foreclose and recoup some or all of its original capital; and the financial, interest rate risk and time delays that may be involved in certain circumstances.

More recently, mortgage loan brokers have expanded their businesses to include a web presence. There is now even a market for standard web templates which are used by brokers who want to quickly develop an online component to their business.

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, 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.


Historical U.S. Prime RatesIn a fixed rate mortgage, the interest rate, and hence periodic payment, remains fixed for the life (or term) of the loan. In the U.S., the term is usually up to 30 years (15 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 U.S. 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.

Additionally, lenders in many markets rely on credit reports and credit scores derived from them. The higher the score, the more creditworthy the borrower is assumed to be. Favorable interest rates are offered to buyers with high scores. Lower scores indicate higher risk for the lender, and higher rates will generally be charged to reflect the (expected) higher default rates.

A partial amortization or balloon loan is one where the amount of monthly payments due are calculated (amortized) over a certain term, but the outstanding principal balance is due at some point short of that term. This payment is sometimes referred to as a "balloon payment" or bullet payment. The interest rate for a balloon loan can be either fixed or floating. The most common way of describing a balloon loan uses the terminology X due in Y, where X is the number of years over which the loan is amortized, and Y is the year in which the principal balance is due.

Loan to value and downpayments
Upon making a mortgage loan for purchase of a property, lenders usually require that the borrower make a downpayment, that is, contribute a portion of the cost of the property. This downpayment may be expressed as a portion of the value of the property (see below for a definition of this term). The loan to value ratio (or LTV) is the size of the loan against the value of the property. Therefore, a mortgage loan where the purchaser has made a downpayment of 20% has a loan to value ratio of 80%. For loans made against properties that the borrower already owns, the loan to value ratio will be imputed against the estimated value of the property.

The loan to value ratio is considered an important indicator of the riskiness of a mortgage loan: the higher the LTV, the higher the risk that the value of the property (in case of foreclosure) will be insufficient to cover the remaining principal of the loan.

Value: appraised, estimated, and actual
Since the value of the property is an important factor in understanding the risk of the loan, determining the value is a key factor in mortgage lending. The value may be determined in various ways, but the most common are:

Actual or transaction value: this is usually taken to be the purchase price of the property. If the property is not being purchased at the time of borrowing, this information may not be available.
Appraised or surveyed value: in most jurisdictions, some form of appraisal of the value by a licensed professional is common. There is often a requirement for the lender to obtain an official appraisal.
Estimated value: lenders or other parties may use their own internal estimates, particularly in jurisdictions where no official appraisal procedure exists, but also in some other circumstances.

[edit] Equity or homeowner's equity
The concept of equity in a property refers to the value of the property minus the outstanding debt, subject to the definition of the value of the property. Therefore, a borrower who owns a property whose estimated value is $400,000 but with outstanding mortgage loans of $300,000 is said to have homeowner's equity of $100,000.

Payment and debt ratios
In most countries, a number of more or less standard measures of creditworthiness may be used. Common measures include payment to income (mortgage payments as a percentage of gross or net income); debt to income (all debt payments, including mortgage payments, as a percentage of income); and various net worth measures. In many countries, credit scores are used in lieu of or to supplement these measures. There will also be requirements for documentation of the creditworthiness, such as income tax returns, pay stubs, etc; the specifics will vary from location to location. Many countries have lower requirements for certain borrowers, or "no-doc" / "low-doc" lending standards that may be acceptable in certain circumstances.

Standard or conforming mortgages
Many countries have a notion of standard or conforming mortgages that define a perceived acceptable level of risk, which may be formal or informal, and may be reinforced by laws, government intervention, or market practice. For example, a standard mortgage may be considered to be one with no more than 70-80% LTV and no more than one-third of gross income going to mortgage debt.

A standard or conforming mortgage is a key concept as it often defines whether or not the mortgage can be easily sold or securitized, or, if non-standard, may affect the price at which it may be sold. In the United States, a conforming mortgage is one which meets the established rules and procedures of the two major government-sponsored entities in the housing finance market (including some legal requirements). In contrast, lenders who decide to make nonconforming loans are exercising a higher risk tolerance and do so knowing that they face more challenge in reselling the loan. Many countries have similar concepts or agencies that define what are "standard" mortgages. Regulated lenders (such as banks) may be subject to limits or higher risk weightings for non-standard mortgages. For example, banks in Canada face restrictions on lending more than 75% of the property value; beyond this level, mortgage insurance is generally required (as of April 2007, there is a proposal to raise this limit to 80%).

Capital and interest
The most common way to repay a loan is to make regular payments of the capital (also called principal) and interest over a set term. This is commonly referred to as (self) amortization in the U.S. and as a repayment mortgage in the UK. A mortgage is a form of annuity (from the perspective of the lender), and the calculation of the periodic payments is based on the time value of money formulas. Certain details may be specific to different locations: interest may be calculated on the basis of a 360-day year, for example; interest may be compounded daily, yearly, or semi-annually; prepayment penalties may apply; and other factors. There may be legal restrictions on certain matters, and consumer protection laws may specify or prohibit certain practices.

Depending on the size of the loan and the prevailing practice in the country the term may be short (10 years) or long (50 years plus). In the UK and U.S., 25 to 30 years is the usual maximum term (although shorter periods, such as 15-year mortgage loans, are common). Mortgage payments, which are typically made monthly, contain a capital (repayment of the principal) and an interest element. The amount of capital included in each payment varies throughout the term of the mortgage. In the early years the repayments are largely interest and a small part capital. Towards the end of the mortgage the payments are mostly capital and a smaller portion interest. In this way the payment amount determined at outset is calculated to ensure the loan is repaid at a specified date in the future. This gives borrowers assurance that by maintaining repayment the loan will be cleared at a specified date, if the interest rate does not change.

Interest only
The main alternative to capital and interest mortgage is an interest only mortgage, where the capital is not repaid throughout the term. This type of mortgage is common in the UK, especially when associated with a regular investment plan. With this arrangement regular contributions are made to a separate investment plan designed to build up a lump sum to repay the mortgage at maturity. This type of arrangement is called an investment-backed mortgage or is often related to the type of plan used: endowment mortgage if an endowment policy is used, similarly a Personal Equity Plan (PEP) mortgage, Individual Savings Account (ISA) mortgage or pension mortgage. Historically, investment-backed mortgages offered various tax advantages over repayment mortgages, although this is no longer the case in the UK. Investment-backed mortgages are seen as higher risk as they are dependent on the investment making sufficient return to clear the debt.

It is not uncommon for interest only mortgages to be arranged without a repayment vehicle, with the borrower gambling that the property market will rise sufficiently for the loan to be repaid by trading down at retirement (or when rent on the property and inflation combine to surpass the interest rate).

No capital or interest
For older borrowers (typically in retirement), it may be possible to arrange a mortgage where neither the capital nor interest is repaid. The interest is rolled up with the capital, increasing the debt each year.

These arrangements are variously called reverse mortgages, lifetime mortgages or equity release mortgages, depending on the country. The loans are typically not repaid until the borrowers die, hence the age restriction. For further details, see equity release.

Interest and partial capital
In the U.S. a partial amortization or balloon loan is one where the amount of monthly payments due are calculated (amortized) over a certain term, but the outstanding capital balance is due at some point short of that term. In the UK, a part repayment mortgage is quite common, especially where the original mortgage was investment-backed and on moving house further borrowing is arranged on a capital and interest (repayment) basis.

Foreclosure and non-recourse lending
In most jurisdictions, a lender may foreclose the mortgaged property if certain conditions - principally, non-payment of the mortgage loan - obtain. Subject to local legal requirements, the property may then be sold. Any amounts received from the sale (net of costs) are applied to the original debt. In some jurisdictions, mortgage loans are non-recourse loans: if the funds recouped from sale of the mortgaged property are insufficient to cover the outstanding debt, the lender may not have recourse to the borrower after foreclosure. In other jurisdictions, the borrower remains responsible for any remaining debt. In virtually all jurisdictions, specific procedures for foreclosure and sale of the mortgaged property apply, and may be tightly regulated by the relevant government; in some jurisdictions, foreclosure and sale can occur quite rapidly, while in others, foreclosure may take many months or even years. In many countries, the ability of lenders to foreclose is extremely limited, and mortgage market development has been notably slower.

United States mortgage process
In the U.S., the process by which a mortgage is secured by a borrower is called origination. This involves the borrower submitting an application and documentation related to his/her financial history and/or credit history to the underwriter. Many banks now offer "no-doc" or "low-doc" loans in which the borrower is required to submit only minimal financial information. These loans carry a slightly higher interest rate (perhaps 0.25% to 0.50% higher) and are available only to borrowers with excellent credit.Sometimes, a third party is involved, such as a mortgage broker. This entity takes the borrower's information and reviews a number of lenders, selecting the ones that will best meet the needs of the consumer.

Loans are often sold on the open market to larger investors by the originating mortgage company. Many of the guidelines that they follow are suited to satisfy investors. Some companies, called correspondent lenders, sell all or most of their closed loans to these investors, accepting some risks for issuing them. They often offer niche loans at higher prices that the investor does not wish to originate.

If the underwriter is not satisfied with the documentation provided by the borrower, additional documentation and conditions may be imposed, called stipulations. The meeting of such conditions can be a daunting experience for the consumer, but it is crucial for the lending institution to ensure the information being submitted is accurate and meets specific guidelines. This is done to give the lender a reasonable guarantee that the borrower can and will repay the loan. If a third party is involved in the loan, it will help the borrower to clear such conditions.

The following documents are typically required for traditional underwriter review. Over the past several years, use of "automated underwriting" statistical models has reduced the amount of documentation required from many borrowers. Such automated underwriting engines include Freddie Mac's "Loan Prospector" and Fannie Mae's "Desktop Underwriter". For borrowers who have excellent credit and very acceptable debt positions, there may be virtually no documentation of income or assets required at all. Many of these documents are also not required for no-doc and low-doc loans.

Credit Report
1003 - Uniform Residential Loan Application
1004 - Uniform Residential Appraisal Report
1005 - Verification Of Employment (VOE)
1006 - Verification Of Deposit (VOD)
1007 - Single Family Comparable Rent Schedule
1008 - Transmittal Summary
Copy of deed of current home
Federal income tax records for last two years
Verification of Mortgage (VOM) or Verification of Payment (VOP)
Borrower's Authorization
Purchase Sales Agreement
1084A and 1084B (Self-Employed Income Analysis) and 1088

Option ARM
An option ARM provides the option to pay as little as the equivalent of an amortized payment based on a 1% interest rate,(please note this is not the actual interest rate). As a result, the difference between the monthly payment and the interest on the loan is added to the loan principal; the loan at this point has negative amortization. In this respect, an option ARM provides a form of equity withdrawal (as in a cash-out refinancing) but over a period of time.

The option ARM gives a number of payment choices each month (for example, the equivalent of an amortized payment were the interest rate 1%, interest only based on actual interest rate, actual 30 year amortized payment, actual 15 year amortized payment). The interest rate may adjust every month in accordance with the index to which the loan is tied and the terms of the specific loan. These loans may be useful for people who have a lot of equity in their home and want to lower monthly costs; for investors, allowing them the flexibility to choose which payment to make every month; or for those with irregular incomes (such as those working on commission or for whom bonuses comprise a large portion of income).

One of the important features of this type of loan is that the minimum payments are often fixed for each year for an initial term of up to 5 years. The minimum payment may rise each year a little (payment size increases of 7.5% are common) but remain the same for another year. For example, a minimum payment for year 1 may be $1,000 per month each month all year long. In year 2 the minimum payment for each month is $1,075 each month. This is a gradual increase in the minimum payment. The interest rate may fluctuate each month, which means that the extent of any negative amortization cannot be predicted beyond worst-case scenario as dictated by the terms of the loan.

Option ARM mortgages have been criticized on the basis that some borrowers are not aware of the implications of negative amortization; that eventually option ARMs reset to higher payment levels (an event called "recast" to amortize the loan), and borrowers may not be capable of making the higher monthly payments; and that option ARMs have been used to qualify mortgages for individuals whose incomes cannot support payments higher than the minimum level.

Costs
Lenders may charge various fees when giving a mortgage to a mortgagor. These include entry fees, exit fees, administration fees and lenders mortgage insurance. There are also settlement fees (closing costs) the settlement company will charge. In addition, if a third party handles the loan, it may charge other fees as well.

The United States mortgage finance industry
Mortgage lending is a major category of the business of finance in the United States. Mortgages are commercial paper and can be conveyed and assigned freely to other holders. In the U.S., the Federal government created several programs, or government sponsored entities, to foster mortgage lending, construction and encourage home ownership. These programs include the Government National Mortgage Association (known as Ginnie Mae), the Federal National Mortgage Association (known as Fannie Mae) and the Federal Home Loan Mortgage Corporation (known as Freddie Mac). These programs work by buying a large number of mortgages from banks and issuing (at a slightly lower interest rate) "mortgage-backed bonds" to investors, which are known as Mortgage Backed Securities (MBS).

This allows the banks to quickly relend the money to other borrowers (including in the form of mortgages) and thereby to create more mortgages than the banks could with the amount they have on deposit. This in turn allows the public to use these mortgages to purchase homes, something the government wishes to encourage. The investors, meanwhile, gain low-risk income at a higher interest rate (essentially the mortgage rate, minus the cuts of the bank and GSE) than they could gain from most other bonds.

Securitization is a momentous change in the way that mortgage bond markets function, and has grown rapidly in the last 10 years as a result of the wider dissemination of technology in the mortgage lending world. For borrowers with superior credit, government loans and ideal profiles, this securitization keeps rates almost artificially low, since the pools of funds used to create new loans can be refreshed more quickly than in years past, allowing for more rapid outflow of capital from investors to borrowers without as many personal business ties as the past.

Mortgage insurance is an insurance policy designed to protect the mortgagee (lender) from any default by the mortgagor (borrower). It is used commonly in loans with a loan-to-value ratio over 80%, and employed in the event of foreclosure and repossession.

This policy is typically paid for by the borrower as a component to final nominal (note) rate, or in one lump sum up front, or as a separate and itemized component of monthly mortgage payment. In the last case, mortgage insurance can be dropped when the lender informs the borrower, or its subsequent assigns, that the property has appreciated, the loan has been paid down, or any combination of both to relegate the loan-to-value under 80%.

In the event of repossession, banks, investors, etc. must resort to selling the property to recoup their original investment (the money lent), and are able to dispose of hard assets (such as real estate) more quickly by reductions in price. Therefore, the mortgage insurance acts as a hedge should the repossessing authority recover less than full and fair market value for any hard asset.