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Residential mortgage loans – features and types

In the US, mortgages are categorized either as prime loans or subprime loans. A loan is a prime loan if the borrower has high credit quality as evident from strong employment and credit histories, sufficient income and substantial equity, otherwise, it is sub-prime.

Mortgage loan structures vary depending on the maturity, determination of interest rate (also called mortgage rate, contract rate or note rate), principal repayment, prepayment option and terms of foreclosure:


In residential mortgage loans, maturity, i.e. the number of years till maturity, which ranges from 15-30 (in the US), up to 40 (in Europe) and up to 100 (in Japan).

Interest rate determination

Interest rates on a mortgage are either fixed, adjustable/variable, the initial period fixed and convertible:

Fixed mortgage loans

Pay a fixed interest rate, predominant in the US.

Adjustable/variable mortgages

The interest rate is reset periodically often specifying the maximum change at any given reset date and maximum interest rate possible, in line with a change in some benchmark rate (indexed-referenced ARM) or at the discretion of the lender (reviewable ARM).

The initial period fixed rate

Pays a fixed rate for an initial period, after which it is adjusted, either as a new fixed-rate (in a rollover or renegotiable mortgage) or as an adjustable-rate (in hybrid mortgage).

Convertible mortgage

A mortgage that can be converted from fixed to adjustable and vice versa at some point.

Amortization schedule

Most mortgages are amortizing in nature i.e. periodic payments are a combination of interest and principal. In a fully-amortizing mortgage, all principal is paid off through periodic payments while in a partially amortizing mortgage, a balloon payment is also needed. Some mortgages, called interest-only mortgages pay no principal repayment during a certain time period. If no principal is repaid over the whole life of the mortgage, they are called interest-only lifetime mortgages or bullet mortgages.

Prepayment option and prepayment penalties

A prepayment option (also called early repayment option) allows borrowers to pay off the mortgage principal before its due. This affects the lender because he receives cash typically when the interest rates are low. This is why many mortgages stipulate penalties on prepayment within a stipulated time of loan origination (which may extend to the whole term of the loan), an extreme case is when the borrower has to pay any difference between the contract rate and current rate to the lender.

Rights of the lender in foreclosure

In a recourse loan (which is common in Europe), a lender is entitled to recover any shortfall that exists between loan amount and proceeds from disposal from the borrower; but not in a non-recourse loan (which are common in the US). The distinction is important because when a loan is non-resource, some borrowers in an underwater mortgage (a mortgage in which loan exceeds property value) may choose to default deliberately in which is called a strategic default.

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