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A mortgage loan is a loan that uses real estate as collateral. Banks and other lenders make these loans to individuals primarily for the purpose of purchasing property. It is important to note, however, that depending on the type of mortgage, the loan can be used for a number of activities ranging from renovation or refinancing, to buying a car. The main thing that most mortgages have in common, is that they use real estate as collateral. This means that if the borrower does not pay back the loan the bank has the right to foreclose on the property.
In the United States mortgage loans are issued by both banks and non-bank loan companies. These companies make money primarily by charging the consumer a rate of interest on the total outstanding amount of the loan. They also charge application fees that can range from a few hundred dollars to several thousand. Finally, a lender may require a borrower to pay points before issuing a mortgage. A point is equal to 1% of the total loan amount.
Mortgage loans are typically much larger than most other types of personal loans. As a result, the screening process to determine borrowers’ eligibility is more rigorous, at least in theory. Banks try to make loans, to borrowers who have high likelihood of paying back the loan, or at the very least try to price the loan at an APR that is high enough to account for any additional risk that they would be taking on by lending to unqualified buyers. Banks judge potential borrowers based on several criteria.
Size of down payment and loan to value (LTV) As part of the loan process the borrower has to get an appraisal on the house or condo that he or she wishes to buy. Based on a serious of inputs – sales values for comparable properties in the same neighborhood and condition of the property) the appraiser comes up with an approximate value for the property. Most banks will not lend a borrower more than the appraised value of the property. In fact most banks prefer to lend significantly less. The size of the loan relative to the value of the property is known as the loan to value. For instance an 80,000 mortgage on a 100,000 property represents an LTV of 80%.
The ability of a borrower to get a loan from a bank and the interest rate he or she pays for that loan depend partly on the size of his or her down payment. A higher down payments means a lower loan to value. The more money the borrower puts down, the more likely he is to be approved and the more likely he is to get a lower interest rate. A minimum down payment of 20% is standard, although in recent years (2000-2008) loans with no money down have been made available to borrowers.
In the United States Fannie Mae and Freddie Mac, both of which are government sponsored entities, purchase home loans from banks and other mortgage lenders. This is a critical to the health of the financial markets, because it means that mortgage lenders do not need to wait 15-30 years to receive full payment for their loans. Instead they sell to Fannie and Freddie and then are free to use the proceeds of the sell to make new loans. This also reduces the risk to the bank of loan defaults, because the bank doesn’t have to hold the loans for long. If a loan issued meets the criteria that Fannie and Freddie set, then it is classified as conforming. Otherwise it is non-conforming. There are several reasons that loan might fail to conform:
Fixed Rate Mortgages: This is the most common type of mortgage. Nearly 70% of mortgages originated in the United States fall into this category.  These mortgages are the least risky, because their rates and thus the borrower's payments are fixed for the life of the loan. Fixed rate mortgages are typically made for a period of 30 years or 15 years, although in recent years, banks have begun offering 40 year mortgages as well.
Interest Only Mortgages – As the name suggests, borrowers with interest only mortgages do not have to pay any principal, but instead pay only the monthly interest on their loans. These loans are typically incorporated as part of another type of loan. For instance, a 30 yr fixed may be interest only for the first 10 years. Over the last 20 years of the loan the borrower pays both principal and interest until the loan is paid off. The avantage of these loans is that the initial monthly payments are lower than the payments would be on a similar fixed rate loan. The disadvantage is that once the interest only period has expired, the borrower has to pay higher payments over the remainder of the loan, to make up for the interest only period.
This loan product functions in the opposite manner of most other types of loans. The payments are set at a level where they do not full cover the interest on the loan. Overtime, the amount that the borrower owes the lender increases as the unpaid interest is added to the initial debt. This loan can sometimes be beneficial to the elderly who need additional cash in their last years. They can borrow against the equity in their house, under the condition that the loan will be repaid by selling the house upon their death.
If an individual needs additional cash he or she can take out another mortgage on their home before paying off the first. There are several scenarios under which this is done.