What is a 'Mortgage
A mortgage is a debt instrument, secured by the collateral of specified real estate property, that the borrower is obliged to pay back with a predetermined set of payments. Mortgages are used by individuals and businesses to make large real estate purchases without paying the entire value of the purchase up front. Over a period of many years, the borrower repays the loan, plus interest, until he/she eventually owns the property free and clear. Mortgages are also known as "liens against property" or "claims on property." If the borrower stops paying the mortgage, the bank can foreclose.
A
mortgage loan, also referred to as a
mortgage, is used by purchasers of
real property to raise funds to buy real estate; by existing property owners to raise funds for any purpose while putting a
lien on the property being mortgaged. The loan is "
secured" on the borrower's property. This means that a
legal mechanism is put in place which allows the lender to take possession and sell the secured property ("
foreclosure" or "
repossession") to pay off the loan in the event that the borrower defaults on the loan or otherwise fails to abide by its terms. The word
mortgage is derived from a "
Law French" term used by
English lawyers in the
Middle Ages
meaning "death pledge", and refers to the pledge ending (dying) when
either the obligation is fulfilled or the property is taken through
foreclosure.
Mortgage can also be described as "a borrower giving consideration in the form of a collateral for a benefit (loan).
Basic Concepts And Legal Regulation
According to Anglo-American
property law, a mortgage occurs when an owner (usually of a
fee simple interest in
realty) pledges his or her interest (right to the property) as
security or
collateral for a loan. Therefore, a mortgage is an
encumbrance (limitation) on the right to the property just as an
easement would be, but because most mortgages occur as a condition for new loan money, the word
mortgage has become the generic term for a
loan secured by such
real property. As with other types of loans, mortgages have an
interest rate and are scheduled to
amortize
over a set period of time, typically 30 years. All types of real
property can be, and usually are, secured with a mortgage and bear an
interest rate that is supposed to reflect the lender's risk.
Mortgage lending is the primary mechanism used in many countries to
finance private ownership of residential and commercial property (see
commercial mortgages). Although the terminology and precise forms will differ from country to country, the basic components tend to be similar:
- Property: the physical residence being financed. The exact form of
ownership will vary from country to country, and may restrict the types
of lending that are possible.
- Mortgage: the security interest
of the lender in the property, which may entail restrictions on the use
or disposal of the property. Restrictions may include requirements to
purchase home insurance and mortgage insurance, or pay off outstanding debt before selling the property.
- Borrower: the person borrowing who either has or is creating an ownership interest in the property.
- Lender: any lender, but usually a bank or other financial institution. (In some countries, particularly the United States, Lenders may also be investors who own an interest in the mortgage through a mortgage-backed security.
In such a situation, the initial lender is known as the mortgage
originator, which then packages and sells the loan to investors. The
payments from the borrower are thereafter collected by a loan servicer.
- Principal: the original size of the loan, which may or may not
include certain other costs; as any principal is repaid, the principal
will go down in size.
- Interest: a financial charge for use of the lender's money.
- Foreclosure or repossession:
the possibility that the lender has to foreclose, repossess or seize
the property under certain circumstances is essential to a mortgage
loan; without this aspect, the loan is arguably no different from any
other type of loan.
- Completion: legal completion of the mortgage deed, and hence the start of the mortgage.
- Redemption:
final repayment of the amount outstanding, which may be a "natural
redemption" at the end of the scheduled term or a lump sum redemption,
typically when the borrower decides to sell the property. A closed
mortgage account is said to be "redeemed"
Many other specific characteristics are common to many markets, but
the above are the essential features. Governments usually regulate many
aspects of mortgage lending, either directly (through legal
requirements, for example) or indirectly (through regulation of the
participants or the financial markets, such as the banking industry),
and often through state intervention (direct lending by the government,
by state-owned banks, or sponsorship of various entities). Other aspects
that define a specific mortgage market may be regional, historical, or driven by specific characteristics of the legal or financial system.
Mortgage loans are generally structured as long-term loans, the periodic payments for which are similar to an
annuity and calculated according to the
time value of money
formulae. The most basic arrangement would require a fixed monthly
payment over a period of ten to thirty years, depending on local
conditions. Over this period the principal component of the loan (the
original loan) would be slowly paid down through
amortization. In practice, many variants are possible and common worldwide and within each country.
Lenders provide funds against property to earn
interest income, and generally borrow these funds themselves (for example, by taking
deposits or issuing
bonds).
The price at which the lenders borrow money therefore affects the cost
of borrowing. Lenders may also, in many countries, sell the mortgage
loan to other parties who are interested in receiving the stream of cash
payments from the borrower, often in the form of a security (by means
of a
securitization).
Mortgage lending will also take into account the (perceived)
riskiness of the mortgage loan, that is, the likelihood that the funds
will be repaid (usually considered a function of the creditworthiness of
the borrower); that if they are not repaid, the lender will be able to
foreclose on the real estate assets; and the financial,
interest rate risk and time delays that may be involved in certain circumstances.
