A mortgage involves the transfer of an interest in land as security for a loan, between the mortgagor (the borrower) and the mortgagee (the lender). There are several different types of mortgages available.
 
Fixed Rate Mortgage A fixed rate mortgage carries an interest rate that will be set at the inception of the loan and remain constant for the length of the mortgage. A 30-year mortgage will have a rate that is fixed for all 30 years. At the end of the 30th year, if payments have been made on time, the loan is fully paid off. To a borrower, the advantage is that the rate will remain constant and the monthly payment will remain the same throughout the life of the loan. The lender is taking the risk that interest rates will rise and it will carry a loan at below market interest rates for some or part of the 30 years. Because of this there is usually a higher interest rate on a fixed rate loan, compared with the initial rate and payments on adjustable rate or balloon mortgages. If the rates fall, homeowners can pay off the loan by refinancing the house at the lower interest rate.
 
Adjustable Rate Mortgage An adjustable rate mortgage (ARM) provides a fixed initial interest rate and a fixed initial monthly payment for a short period of time. With an ARM, after the initial fixed period, which can be anywhere from six months to six years, both the interest rate and the monthly payments adjust on a regular basis to reflect the current market interest. Some ARMs may be subject to adjustment every three months while others may be adjusted once a year. Also, some ARMs limit the amount that the rates can change. While an ARM usually carries a lower initial interest rate and lower initial monthly payment, the purchaser is taking the risk that rates may rise in the future.
 
Owner Carryback and Financing An alternative form of financing -- usually a last resort for those who cannot qualify for other mortgages -- is owner financing or owner carryback. The owner finances or "carries" all or part of the mortgage. Owner financing often involves balloon mortgage payments, since the monthly payments are frequently interest-only. A balloon mortgage has a fixed interest rate and fixed monthly payment, but after a fixed period of time (such as five or ten years) the whole balance of the loan becomes due at once. This means that the buyer must either pay the balloon loan off in cash or refinance the loan at current market rates. Home Equity Loan A home equity loan is usually used by homeowners to borrow some of the equity in the home. Doing so may raise the monthly housing payment considerably. More and more lenders are offering home equity lines of credit. The interest may be tax-deductible because the debt is secured by a home. A home equity line of credit is a form of revolving credit secured by a home. Many lenders set the credit limit on a home equity line by taking a percentage of the home's appraised value and subtracting from that the balance owed on the existing mortgage. In determining the credit limit, the lender will also consider other factors to determine the homeowner's ability to repay the loan. Many home equity plans set a fixed period during which money can be borrowed. Some lenders require payment in full of any outstanding balance at the end of the period. Home equity lines of credit usually have variable rather than fixed interest rates. The variable rate must be based on a publicly available index -- such as the prime rate published in major daily newspapers -- or a U. S. Treasury bill rate. The interest rate for borrowing under the home equity line will change in accordance with the index. Most lenders set the interest rate at the value of the index at a particular time plus a margin, such as 3 percentage points. The cost of borrowing is tied directly to the value of the index. Lenders sometimes offer a temporarily discounted interest rate for home equity lines. This is a rate that is unusually low and may last for a short introductory period of merely a few months. The cost of setting up a home equity line of credit typically includes a fee for a property appraisal, an application fee, fees for attorneys, title search, mortgage preparation and filing fees, property and title insurance fees, and taxes. There may also be recurring maintenance fees for the account or a transaction fee every time there is a draw on the credit line. It might cost a significant amount of money to establish the home equity line of credit, although interest savings can justify the cost of establishing and maintaining the line. The federal Truth in Lending Act requires lenders to disclose the important terms and costs of their home equity plans, including the APR, miscellaneous charges, the payment terms, and information about any variable-rate feature. If the home involved is a principal dwelling, the Truth in Lending Act allows 3 days from the day the account was opened to cancel the credit line. This right allows the borrower to cancel for any reason by informing the lender in writing within the 3-day period. The lender must then cancel its security interest in the property and return all fees.
 
Second Mortgage A second mortgage provides a fixed amount of money repayable over a fixed period. In most cases the payment schedule calls for equal payments that will pay off the entire loan within the loan period. A second mortgage differs from a home equity loan in that it is not a line of credit, but rather a more traditional type of loan. The traditional second mortgage loan takes into account the interest rate charged, plus points and other finance charges. The annual percentage rate for a home equity line of credit is based on the periodic interest rate alone. It does not include points or other charges.
 
Reverse Mortgage A reverse mortgage works much like traditional mortgages, only in reverse. It allows homeowners to convert the equity in a home into cash. A reverse mortgage permits retired homeowners who own their home and have paid all of their mortgage to borrow against the value of their home. The lender pays the equity to the homeowner in either payments or a lump sum. Unlike a standard home equity loan, no repayment is due until the home is no longer used as a principal residence, a sale of the home, or death of the homeowner.
 
Prepayment Penalty Clause A prepayment penalty is a charge the borrower pays when a mortgage is repaid before a certain period of time elapses. Not all lenders impose a prepayment penalty. From a mortgage lender's perspective a prepayment penalty helps the lender at least recoup some or all of the significant expense it incurs in putting a new loan on the books. If the loan is to be repaid quickly due to a refinance, the lender may have a significant loss. A prepayment penalty provision must be set out in the mortgage contract in order for the lender to collect one.
 
Mortgage Contingency Clause A mortgage contingency clause is a provision in the home purchase contract that says that if the prospective buyer cannot get a mortgage within a fixed period of time, the buyer may cancel the entire transaction.