Real Estate Collateral

• A mortgage is a secured loan, where your real estate serves as collateral. In the event of mortgage default, the bank has the right to seize your home and auction it off to make good on your unpaid principal balance. To protect its financial interests, the bank will therefore perform a property appraisal prior to mortgage loan approval. The bank will verify that the value of your future home is at least equal to your original mortgage principal balance. The bank collects interest, in exchange for lending out mortgage principal.
  
  

Monthly Mortgage Payment

• To uphold your part of the mortgage contract, you agree to pay off the loan in monthly installments. Monthly mortgage payments help you establish equity, or financial ownership, in the home. To calculate home equity, you subtract the amount of your outstanding mortgage principal balance from the value of your home. Each mortgage payment is divided between escrow account deposits and principal and interest payments. Through the mortgage escrow account, you pay property taxes and private mortgage insurance (PMI) premiums. PMI further protects the bank against financial losses because it pays out a cash settlement to the financial institution in the event of mortgage default.
  
  

Interest Rate Calculations

• The mortgage contract specifies interest rate calculations for your home loan. In terms of interest charges, a home loan can be classified as either a fixed or adjustable rate mortgage (ARM). A fixed rate mortgage charges the same interest rate throughout its term, which may last for 15 or 30 years. As a conservative borrower, you would prefer a fixed rate mortgage that allows you to budget around regular housing payments. An adjustable rate mortgage features interest rates that change regularly according to the interest rate environment. For example, your monthly ARM rate may add a 5 percent premium to the current prime rate. You could consider an adjustable rate mortgage if you expect future interest rates to decline. Interest rates typically decline when a strong economy deteriorates into a recession, which results in weak loan demand.
  
  

Foreclosure

• After 30 days of missed payments, your mortgage falls into default, and the foreclosure process begins with the pre-foreclosure stage. In pre-foreclosure, you typically have 150 days to sell your home, pay off the mortgage and avoid further damage to your credit. If a buyer does not materialize, the bank will post a notice of sale to announce a time and date for your home to be auctioned off. Immediately after the auction, the home's new owner can file an eviction lawsuit and remove you from the premises.