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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. |
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• 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.
The charge to the borrower depends upon the credit risk in addition to the
interest rate risk. The mortgage origination and underwriting process
involves checking credit scores, debt-to-income, down payments, and assets.
Jumbo mortgages and sub-prime lending are not supported by government
guarantees and face higher interest rates. Other innovations described below
can affect the rates as well.
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