Introduction to Finance

fi xed-rate mortgage
typically has a fi xed interest rate and constant 
monthly payments over the life of the loan, which is typically 15 or 30 years. A loan that is 
repaid in equal payments over a specifi ed time period is referred to as an 
amortized 
loan. We 
discuss amortized loans in Chapter 9. The traditional fi xed-rate residential mortgage loan also 
required a sizeable down payment, typically 20 percent of the house purchase price, at the time 
the loan was made.
Holders of fi xed-rate mortgages benefi ted by knowing that their monthly mortgage pay-
ment would not change over the loan’s life, and thus they could plan and budget for the 
contractual monthly payment amounts. As a result, the 
default rate
, or failure to make timely 
periodic payments, was low on fi xed-rate mortgage loans. However, the benefi ts of fi xed-rate 
mortgages were off set, in part, by the fact that only a portion of the U.S. population could 
qualify to purchase their own houses. 
During the past couple of decades, a period of generally high fi xed-rate mortgage loan 
interest rates and a time in which it was desired to extend housing ownership to more individu-
als in the United States, the use of adjustable-rate mortgages grew. An 
adjustable-rate mort-
gage (ARM)
has an interest rate that changes or varies over time with market-determined 
interest rates based on a U.S. Treasury bill or other debt security. The interest rate on an ARM 
is often adjusted annually to refl ect changes in U.S. Treasury bill rates (or other interest rate 
benchmark). Also, lenders typically off er ARMs with variable interest rates for one to fi ve 
years with a provision to switch to a fi xed rate over the remaining life of the ARM. 
Because ARMs, typically, off er lower initial interest rates and lower monthly payments, 
more individuals can qualify for home ownership. However, because of possible changing 
market-determined interest rates and potential changeovers to fi xed interest rates, individuals 
who were able to make initially low monthly mortgage payments may fi nd themselves unable 
to meet their mortgage payments if interest rates are adjusted upwards.
Mortgage loans are originated in the primary mortgage markets by mortgage brokers, 
mortgage companies, and depository fi nancial institutions, which include banks, savings and 
loan associations, savings banks, and credit unions. Mortgage brokers and mortgage compan-
ies typically sell the mortgage loans they originated in the secondary mortgage markets. Com-
mercial banks, which are the dominant type of depository institution that originate mortgage 
loans, either hold and collect the periodic payments by borrowers on the loans they originated 
or sell the loans in the secondary mortgage markets.
In some instances, banks and other mortgage lenders “pool” together loans they origin-
ated into securities. Other fi nancial intermediaries “repackage” mortgage loans into securities.