A mortgage occurs when an owner pledges his or her interest as security or collateral for a loan. Therefore, a mortgage is an encumbrance on the right to the 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 be, and usually are, secured with a mortgage and bear an interest rate that is supposed to reflect the lender's risk.

Mortgage loan types

The two basic types of amortized loans are the fixed rate mortgage (FRM) and adjustable-rate mortgage (ARM). In a fixed rate mortgage, the interest rate, and periodic payment, remains fixed for the life of the loan. Therefore the payment is fixed, although property taxes and insurance can 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 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 subprime lending are not supported by government guarantees and face higher interest rates.