A home mortgage is a long-term loan for the purchase of a home, secured by the value of the home itself.
Banks as well as mortgage companies make mortgage loans to consumers and charge an interest rate for the duration of the loan that may be fixed or variable. Mortgage loans generally last for between 15 to 30 years, and they are constructed so that paying off a home can fit into a person’s budget while a bank or lending institution collects interest on each payment.
Payments may also include the cost of private mortgage insurance (PMI), which is required if a borrower does not pay at least 20% of the value of the home up front as a down payment, and it protects the lending institution from the risk of non-payment or foreclosure. PMI is not required after a borrower has paid off 80% of the principal amount.
The portion of each payment that goes toward paying down the principal amount of the loan builds up the homeowner’s equity in the house. Home equity is an asset on the individual’s balance sheet, and can be used as collateral for loans.
The interest rate due on mortgages can be fixed at a certain rate from the beginning or may fluctuate according to the interest rate environment, or a combination of the two. People can be approved to refinance their loans with a new interest rate and/or a different length of term.
The mortgage lending industry has a large securities market attached to it, as cash flows from mortgage loans are purchased by entities such as Fannie Mae and Freddie Mac and are sold off as bond-like instruments called collateralized mortgage obligations (CMOs), which were part of the financial meltdown of 2008.