One critical housing decision that households make is whether to rent or to own. Multiple factors influence the decision, such as a household's financial status and expectations about the future. Homeownership offers advantages such as tax deductions, the possibility of increasing wealth through price appreciation, and relatively stable housing costs. In contrast, purchasing a home has expenses, such as a real estate agent's commission, the time and effort involved in searching for a new home, the cost of a home inspection, and various state and local fees, which might deter homeownership. Furthermore, homeowners also face the risk that house prices could decrease. These costs can make homeowners less mobile than renters and less able to move elsewhere to take advantage of employment opportunities. Few homebuyers have sufficient financial resources to make the purchase without borrowing money. Most need to take out a loan known as a mortgage. This report serves as a primer that explains how the system of housing finance works. It focuses on single-family, owner-occupied housing not on rental, commercial, or multi-family real estate. Historically, the government has played an important role in the housing finance system, both supporting the system and regulating it. As described in more detail in the " Lender Protection " section, the government provides explicit support to certain homeowners through government agencies such as the Federal Housing Administration (FHA) and implicit support to others, such as through the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. Advocates of government support for homeownership argue that homeownership strengthens ties to community and may allow households to accumulate wealth. The government's support attempts to balance two competing objectives: (1) expanding access to homeownership for qualified borrowers and (2) minimizing the risk and cost to the government. The government's regulation of the housing finance system is divided across the different levels of government. Some issues, such as the foreclosure process, are primarily regulated by the states, while other issues, such as certain borrower protections when taking out a mortgage, are regulated at the federal level. This report largely focuses on the federal role in supporting housing finance, not on its role in the regulation of it. The housing finance system has two major components: a primary market and a secondary market . Lenders make new loans in the primary market, and loans are bought and sold by financial institutions in the secondary market. The next section describes the primary market, explaining what a mortgage is and how a mortgage is made. The following section describes the secondary market. The Appendix provides a glossary of terms used in this report as well as other common mortgage terms. In the primary market, a lender extends a loan to a borrower to purchase a house. Many different types of lenders, including banks, credit unions, and finance companies (institutions that lend money but do not necessarily accept deposits) make home loans. A loan that uses real estate as collateral is typically referred to as a mortgage . When a borrower applies for a mortgage, the lender will underwrite, or evaluate, the borrower. The lender may consider multiple factors, such as the applicant's credit history, income, debts, assets, and the value of the house being purchased. The underwriting process usually takes several weeks or a month as the borrower assembles various financial documents, such as tax returns, that the lender requires. The mortgage application process can be relatively expensive for borrowers. The borrower pays a variety of upfront fees for items such as credit reports, an independent appraisal, a land survey, a title search, and lender fees. The borrower generally has to pay additional costs when the mortgage documents are signed at what is called a closing . Collectively, these are referred to as settlement costs or closing costs . The borrower and the seller can negotiate who will pay which fees, but the borrower is generally responsible for at least some closing costs. By law, the lender is required to provide a standardized form to the borrower at closing that shows the itemized closing costs associated with the mortgage. A mortgage has four basic characteristics: 1. the amount of the loan (the principal), 2. the length (or term) of the loan, 3. the schedule for the loan's repayment (monthly installments or lump sum), and 4. the interest rate. Different types of mortgages vary across these characteristics. A fixed-rate mortgage is a mortgage in which the interest rate does not change over the life of the loan. An adjustable-rate mortgage has an interest rate that is tied to an underlying index; at agreed-upon intervals, as the index adjusts, so does the interest rate and the monthly payments. A balloon mortgage has a lump-sum amount, or a balloon payment , due at the end of the loan. The most common type of mortgage in the United States is the 30-year, fixed-rate, self-amortizing mortgage, in which every payment is the same amount and pays some of the interest and some of the principal until the loan is paid off. For example, if a borrower takes out a $200,000 mortgage with a 6.5% fixed interest rate to be repaid over 30 years, the borrower's monthly payment is about $1,264. After 360 months of making monthly payments of $1,264 (one payment per month for 30 years), the mortgage is completely paid off. Although the typical mortgage contract may have a 30-year term, most mortgages are paid off early. Borrowers pay off a mortgage in several ways. First, a borrower can repay the loan in full over the prescribed time period or earlier if the borrower makes extra payments. Second, the borrower can refinance the mortgage. In a refinance, the borrower takes out a new mortgage (usually with better terms than the original, such as a lower interest rate), using the new mortgage to repay the original mortgage. The borrower then makes payments on the new mortgage. Third, a borrower can sell the home and use the proceeds to repay the mortgage. When taking out a mortgage, the house that is being purchased is pledged as collateral. If the borrower is unable or unwilling to pay, the lender can seize the house and sell it to recoup what is owed. To increase the probability that the sale of the house will be sufficient to recover the amount of the mortgage outstanding (and to reduce the advantage to the homeowner of defaulting), the lender will generally require a down payment . The down payment also serves as a buffer to protect the lender in the event that house prices fall. For example, if a borrower wants to purchase a $400,000 house, the borrower might make a $100,000 down payment (25%) in order to borrow the $300,000 needed. As long as the house can be sold for more than the amount of the mortgage outstanding, the lender faces little risk of not being repaid. A larger down payment results in a lower loan-to-value ratio (i.e., the ratio of the amount of the mortgage to the value of the home). Although lenders typically require a 20% down payment, a borrower could use mortgage insurance instead, if he or she does not have enough for a 20% down payment. Mortgage insurance, an insurance policy purchased by either the borrower or the lender (though usually by the borrower), compensates the lender in the event that the borrower defaults. It provides greater assurance to the lender of being repaid. Borrowers typically purchase mortgage insurance from private businesses ( private mortgage insurance or PMI) or the federal government. Government mortgage insurance coverage varies depending on the agency providing the insurance, but most programs have lower down payment requirements than other types of mortgages or may not require a down payment at all. The three main agencies that provide government mortgage insurance are Federal Housing Administration (FHA) . FHA, an agency within the Department of Housing and Urban Development (HUD), provides mortgage insurance on loans that meet its requirements (including a minimum down payment requirement and an initial principal balance below a certain threshold) in exchange for fees, or premiums, paid by borrowers. If a borrower defaults on an FHA-insured mortgage, FHA will repay the lender the entire remaining principal amount it is owed. FHA is the largest provider of government mortgage insurance. Department of Veterans Affairs (VA) . VA provides a guaranty on certain mortgages made to veterans. If a borrower defaults on a VA-guaranteed mortgage, the VA will repay the lender a portion (but not all) of the remaining principal amount owed. Because it is limited to veterans, the VA loan guaranty program is smaller and more narrowly targeted than FHA. U.S. Department of Agriculture ( USDA ) . USDA administers a direct loan program for low-income borrowers in rural areas, and a loan guarantee program for low- and moderate-income borrowers in rural areas. If a borrower defaults on a USDA-guaranteed loan, USDA repays the lender a portion (but not all) of the remaining principal amount owed. The USDA program is more narrowly targeted than FHA in that it has income limits and is limited to rural areas. After a loan is made, the borrower is responsible for making the required payments. In the housing finance system, a mortgage servicer is usually hired by the lender to function as the intermediary between the lender and the borrower. The servicer receives a fee out of the monthly proceeds for its work. The role of the servicer may be performed by the same institution that made the loan to the borrower or by another institution. When a borrower is current (making the required payments on time), a mortgage servicer collects payments from the borrower and forwards them to the lender.