Mortgages

Property law
Part of the common law series
Acquisition of property
Gift  · Adverse possession  · Deed
Lost, mislaid, and abandoned property
Bailment  · Licence
Estates in land
Allodial title  · Fee simple
Life estate  · Fee tail  · Future interest
Concurrent estate  · Leasehold estate
Conveyancing of interests in land
Bona fide purchaser  · Torrens title
Estoppel by deed  · Quitclaim deed
Mortgage  · Equitable conversion
Action to quiet title
Limiting control over future use
Restraint on alienation
Rule against perpetuities
Rule in Shelley's Case
Doctrine of worthier title
Nonpossessory interest in land
Easement  · Profit
Covenant running with the land
Equitable servitude
Related topics
Fixtures  · Waste  · Partition
Riparian water rights
Lateral and subjacent support
Assignment  · Nemo dat
Other areas of the common law
Contract law  · Tort law
Wills and trusts
Criminal Law  · Evidence

A mortgage is a method of using property as security for the payment of a debt.

Technically the term mortgage (from Law French, lit. "dead pledge") refers to the legal device used in securing the property, but it is also commonly used to refer to the debt secured by the mortgage.

In most jurisdictions mortgages are strongly associated with loans secured on real estate rather than other property (such as ships) and in some cases only land may be mortgaged. Arranging a mortgage is seen as the standard method by which individuals or businesses can purchase residential or commercial real estate without the need to pay the full value immediately.

In many countries it is normal for home purchase to be funded by a mortgage. In countries where the demand for home ownership is highest, strong domestic markets have developed; notably in Great Britain, Spain & USA.

Participants and variant terminology

Each legal system tends to share certain concepts but varies in the terminology and jargon they use.

In general terms the main participants in a mortgage are:

• The creditor - variously referred to as the mortgagee or lender.

They have legal rights to the debt secured by the mortgage and often make a loan to the debtor of the purchase money for the property. Typically creditors are banks, insurers or other financial institutions who make loans available for the purpose of real estate purchase.

• The debtor(s) - variously referred to as the mortgagor(s) or borrower(s).

They must meet the requirements of the mortgage conditions (and often the loan conditions) imposed by the creditor in order to avoid the creditor enacting provisions of the mortgage to recover the debt. Typically the debtors will be the individual home-owners, landlords or businesses who are purchasing their property by way of a loan.

Other Participants

Due to the complicated legal exchange (conveyance) of the property one or both of the main participants are likely to require legal representation. The terminology varies with legal jurisdiction, see: lawyer, solicitor and conveyancer.

Due to the complex nature of many markets the debtor may approach a mortgage broker or financial adviser to help them source an appropriate creditor typically by finding the most competitive loan.

The debt is sometimes referred to as the hypothecation.

Legal Aspects

There are essentially two types of legal mortgage:

• Mortgage by demise - The creditor becomes the owner of the mortgaged property until the loan is repaid in full (known as "redemption"). This kind of mortgage takes the form of a conveyance of the property to the creditor, with a condition that the property will be returned on redemption.

This is an older form of legal mortgage and is less common than a mortgage by legal charge.

• Mortgage by legal charge (also known as standard security in Scotland) - The debtor remains the legal owner of the property, but the creditor gains sufficient rights over it to enable them to enforce their security, such as a right to take possession of the property or sell it.

To protect the lender, a mortgage by legal charge is usually recorded in a public register. Since mortgage debt is often the largest debt owed by the debtor, banks and other mortgage lenders run title searches of the real property to make certain that there are no mortgages already registered on the debtor's property which might have higher priority. Tax liens, in some cases, will come ahead of mortgages. For this reason, if a borrower has delinquent property taxes, the bank will often pay them to prevent the lienholder from foreclosing and wiping out the mortgage.

This type of mortgage is common in US and, since 1925, it has been the usual form of mortgage in England and Wales.

History

At common law, a mortgage was a conveyance of land that on its face was absolute and conveyed a fee simple estate, but which was in fact conditional, and would be of no effect if certain conditions were not met --- usually, but not necessarily, the repayment of a debt to the original landowner. Hence the word "mortgage," Law French for "dead pledge;" that is, it was absolute in form, and unlike a "live gage", was not conditionally dependent on its repayment solely from raising and selling crops or livestock, or of simply giving the fruits of crops and livestock coming from the land that was mortgaged. The mortgage debt remained in effect whether or not the land could successfully produce enough income to repay the debt. In theory, a mortgage required no further steps to be taken by the creditor, such as acceptance of crops and livestock, for repayment.

The difficulty with this arrangement was that the lender was absolute owner of the property and could sell it, or refuse to reconvey it to the borrower, who was in a weak position. Increasingly the courts of equity began to protect the borrower's interests, so that a borrower came to have an asbolute right to insist on reconveyance on redemption. This right of the borrower is known as the "equity of redemption".

This arrangement, whereby the mortgagee (the lender) was on theory the absolute owner, but in practice had few of the practical rights of ownership, was seen in many jurisdictions as being awkwardly artificial. By statute the common law position was altered so that the mortgagor would retain ownership, but the mortgagee's rights, such as foreclosure, the power of sale and the right to take possession would be protected.

In the United States, those states that have reformed the nature of mortgages in this way are known as lien states. A similar effect was achieved in England and Wales by the Law of Property Act 1925, which abolished mortgages by the conveyance of a fee simple. In the U.S. mortgages got really started in 1934. In that year the Federal Housing Administration lowered the down payment requirements by offering 80 loan-to-value loans. Next, banks, insurance companies, and other lenders followed the example. The FHA also lengthened loan terms by first introducing 15-year loans to supplant 3, 5, and 7-years loans which ended with a balloon payment.

Until the 1930s only 40% of households owned homes, the rate today is nearly 70%.

In 2003, total U.S. residential mortgage production reached a record level of $3.8 trillion through record low interest rates (though these continue to vary according to credit rating [1]).

Repaying the capital

There are various ways to repay a mortgage loan depending on your locality, tax laws and prevailing culture.

Capital & interest

The most common way to repay a loan is make regular payments of the capital and interest over a set term. This is commonly referred to as (self) amortization in the US and as a repayment mortgage in the UK. Depending on the size of the loan and the prevailing practise in the country the term may be short (10 years) or long (50 years plus). In the UK and US 25 to 30 years is typical. Mortgage repayments, which are typically made monthly, contain a capital element and an interest element. The amount of capital included in each repayment varies throughout the term of the mortgage. In the early years the repayments are largely interest and a small part capital. Towards the end of the mortgage the repayments are mostly capital and a small part interest. In this way the repayment amount determined at outset is calculated to ensure the loan is repaid at a specified period in the future. This gives borrowers assurance that by maintaining repayment the loan will definitely be cleared at a specified date.

Interest only

The main alternative to capital and interest mortgage is an interest only mortgage where the capital is not repaid throughout the term. This type of mortgage is common in the UK especially when associated with a regular investment plan. With this arrangement a regular contributions are made to a separate investment plan designed to build up a lump sum to repay the mortgage at maturity. This type of arrangement is called an investment-backed mortgage or is often related to the type of plan used: endowment mortgage if an endowment policy is used, similarly a PEP mortgage, ISA mortgage or pension mortgage. Historically investment-backed mortgages offered various tax advantages over repayment mortgages although this is no longer the case in the UK. Investment-backed mortgages are seen as higher risk as they are dependedent on the investment making sufficient return to clear the debt.

It is not uncommon for interest only mortgage to be arranged without a repayment vehicle with the borrrower gambling that the property market will rise sufficiently for the loan to be repaid by trading down at retirement or for other less well thought-out reasons.

No capital or interest

For older borrowers (typically in retirement) it is possible to arrange a mortgage where neither the capital nor interest is repaid. The interest is rolled up with the capital increasing the debt each year.

These arrangements are variously called reverse mortgages, lifetime mortgages or equity release mortgages in different countries. The loans are typically not repaid until the borrowers die, hence the age restriction. For further details see equity release.

Interest and partial capital

In the US a partial amortization or balloon loan is one where the amount of monthly payments due are calculated (amortized) over a certain term, but the outstanding capital balance is due at some point short of that term. In the UK a part repayment mortgage is quite common especially where the original mortgage was investment-backed and on moving house further borrowing is arranged on a capital & interest (repayment) basis.

Mortgages in the US

Mortgage loan types

There are many types of mortgage loans. The two basic types of amortized loans are the fixed rate mortgage (FRM) and adjustable rate mortgage (ARM).

In a FRM, the interest rate, and hence monthly payment, remains fixed for the life (or term) of the loan. In the U.S., the term is usually for 10, 15, 20, or 30 years.

In an ARM, the interest rate is fixed for a period of time, after which it will periodically (annually or monthly) adjust up or down to some market index. Common indices in the U.S. include the Prime Rate, the LIBOR, and the Treasury Index ("T-Bill"). Other indexes like 11th District Cost of Funds Index, COSI, and MTA, are also available but are less popular.

Adjustable rates transfer part of the interest rate risk from the lender to the borrower, and thus are widely used where unpredictable interest rates make fixed rate loans difficult to obtain. Since the risk is transferred, lenders will usually make the initial interest rate of the ARM's note anywhere from 0.5% to 2% lower than the average 30-year fixed rate.

In most scenarios, the savings from an ARM outweigh its risks, making them an attractive option for people who are planning to keep a mortgage for ten years or less.

A partial amortization or balloon loan is one where the amount of monthly payments due are calculated (amortized) over a certain term, but the outstanding principal balance is due at some point short of that term. A balloon loan can be either a Fixed or Adjustable in terms of the Interest Rate. Many Second Trust mortgages use this feature. The most common way of describing a balloon loan uses the terminology X due in Y, where X is the number of years over which the loan is amortized, and Y is the year in which the principal balance is due.

Other loan types:

• blanket loan
• bridge loan
• budget loan
• Commercial Loan
• deed of trust
• equity loan
• hard money loan
• package loan
• participation mortgage
• reverse mortgage
• repayment mortgage
• seasoned mortgage
• term loan or interest-only loan
• wraparound mortgage
• Negative amortization loan

US Mortgage Process

In the USA, the process by which a mortgage is secured by a borrower is called origination. This involves the borrower submitting an application and documentation related to his/her financial history to the underwriter. Many banks now offer "no-doc" or "low-doc" loans in which the borrower is required to submit only minimal financial information. These loans carry a slightly higher interest rate (perhaps 0.25% to 0.50% higher) and are available only to borrowers with excellent credit.

Sometimes, a third party is involved, such as a mortgage broker. This entity takes the borrower's information and reviews a number of lenders, selecting the ones that will best meet the needs of the consumer.

Loans are often sold on the open market to larger investors by the originating mortgage company. Many of the guidelines that they follow are suited to satisfy investors. Some companies, called correspondent lenders, sell all or most of their closed loans to these investors, accepting some risks for issuing them. They often offer niche loans at higher prices that the investor does not wish to originate.

If the underwriter is not satisfied with the documentation provided by the borrower, additional documentation and conditions may be imposed, called stipulations. The meeting of such conditions can be a daunting experience for the consumer, but it is crucial for the lending institution to ensure the information being submitted is accurate and meets specific guidelines. This is done to give the lender a reasonable guarantee that the borrower can and will repay the loan. If a third party is involved in the loan, it will help the borrower to clear such conditions.

The following documents are typically required for traditional underwriter review. Over the past several years, use of "automated underwriting" statistical models has reduced the amount of documentation required from many borrowers. Such automated underwriting engines include Freddie Mac's "Loan Prospector" and Fannie Mae's "Desktop Underwriter". For borrowers who have excellent credit and very acceptable debt positions, there may be virtually no documentation of income or assets required at all. Many of these documents are also not required for no-doc and low-doc loans.

• credit report
• 1003 -- Uniform Residential Loan Application
• 1004 -- Uniform Residential Appraisal Report
• 1005 -- Verification Of Employment (VOE)
• 1006 -- Verification Of Deposit (VOD)
• 1007 -- Single Family Comparable Rent Schedule
• 1008 -- Transmittal Summary
• Copy of deed of current home
• federal income tax records for last two years
• Verification Of Mortgage (VOM) or Verification Of Payment (VOP)
• Borrower's Authorization
• Purchase Sales Agreement
• 1084A and 1084B (Self-Employed Income Analysis) and 1088 (Comparative Income Analysis) -- used if borrower is self-employed

Costs

Lenders may charge various fees when giving a mortgage to a mortgagor. These include entry fees, exit fees, administration fees and lenders mortgage insurance. There are also settlement fees (closing costs) the settlement company will charge. In addition, if a third party handles the loan, it may charge other fees as well.

US Mortgage finance industry

Mortgage lending is a major category of the business of finance in the United States of America. Mortgages are commercial paper and can be conveyed and assigned freely to other holders. In the U.S., the Federal Housing Administration administers the programs colloquially known as "Ginnie Mae", Fannie Mae and "Freddie Mac" (also known as the GSEs or government sponsored entities) to foster mortgage lending and thus to encourage home ownership and construction. These programs work by buying a large number of mortgages from banks and issuing (at a slightly lower interest rate) "mortgage-backed bonds" to investors known as MBS or Mortgage Backed Securities.

This allows the banks to quickly relend the money to other borrowers (including in the form of mortgages) and thereby to create more mortgages than the banks could with the amount they have on deposit. This in turn allows the public to use these mortgages to purchase homes, something the government wishes to encourage. The investors, meanwhile, gain low-risk income at a higher interest rate (essentially the mortgage rate, minus the cuts of the bank and GSE) than they could gain from most other bonds.

Securitization is a momentous change in the way that mortgage bond markets function which has grown rapidly in the last 10 years as a result of the wider dissemination of technology in the mortgage lending world. For borrowers with superior credit, government loans and ideal profiles, this securitization keeps rates almost artificially low, since the pools of funds used to create new loans can be refreshed more quickly than in years past, allowing for more rapid outflow of capital from investors to borrowers without as many personal business ties as the past.

Glossary of US Mortgage Terms

• Adjustable Rate Mortgage (ARM)
• Amortization (business)
• Fixed-Rate Mortgage (FRM)
• Fannie Mae - Federal National Mortgage Association.
• Fair Isaac (FICO) - One of the three main credit bureaus. A FICO score of 600 would be similar to a "C" in public school grading.
• FHLB Advances - Funding provided by Federal Home Loan Banks.
• Freddie Mac - Federal Home Loan Mortgage Corporation.
• Government Sponsored Entity (GSE) - Private organizations with government charters whose function is to provide liquidity for the residential loan market. GSEs purchase loans from lenders and assume risk for the asset, thereby protecting the investors in the MBS.
• Home Equity Loan (HEL)
• Homeowners Insurance - Package policy that combines (1) coverage against the insured’s property being destroyed or damaged and (2) coverage for liability exposure of the insured.
• Jumbo mortgages - Loans with high risk of default ab initio.
• Loan to value (LTV) - Loan Amount / Value of property.
  • Combined loan to value (CLTV). All loans outstanding (i.e. 1st & 2nd) / Value of property.
• No Income No Asset (NINA)
• No Income Verification (NIV) Income is not verified but many times is "Stated" by the applicant borrower.
• No Documentation (No Doc) Income or assets are not stated. Typically requires a low LTV and higher credit scores.
• Manufactured housing (MH)
• Mortgage Insurance (MI)
• Mortgage Servicing Rights Mortgage Service Rights (MSR) - The capitalized asset that represents the value of the servicing fees to be realized over the life of the loan. (See also yield to maturity)
• Pooling — The process of grouping together mortgage loans with similar characteristics.
• Quitclaim deed (QCD)
• Real estate appraisal
• Second mortgage Additional loan that is subordinate to the primary mortgage
• Secondary mortgage market — The market where lenders and investors buy and sell existing mortgages and MBS securities.
• Securitization — The process of pooling loans into mortgage-backed securities for sale into the secondary mortgage market.
• Verification of employment (VOE)

Mortgage in the UK

Mortgage types

The UK mortgage market is one of the most innovative and competitive in the world. Unlike other countries there is no intervention in the market by the state or state funded entities and virtually all borrowing is funded by either mutual organisations (building societies and credit unions) or proprietary lenders (typically banks). Since 1982, when the market was substantially deregulated, there has been substantial innovation and diversification of strategies employed by lenders to attract borrowers. This has lead to a wide range of mortgage types.

As lenders derive their funds either from the money markets or from deposits, most mortgages revert to a variable rate, either the lenders standard variable rate or a tracker rate, which will tend to be linked to the underlying Bank of England repo rate (or sometime LIBOR). Initially they will tend to offer an incentive deal to attract new borrowers. This may be:

• A fixed rate; where the interest rate remains constant for a set period; typically for 2, 3, 4, 5 or 10 years. Longer term fixed rates (over 5 years) whilst available, tend to be more expensive and therefore less popular than shorter term fixed rates.
• A discount rate; where there is set margin reduction in the standard variable rate (e.g. a 2% discount) for a set period; typically 1 to 5 years. Sometimes the discount is expressed as a margin over the base rate (e.g. BoE base rate plus 0.5% for 2 years) and sometimes the rate is stepped (e.g. 3% in year 1, 2% in year 2, 1% in year three).
• A cashback mortgage where a lump sum is provided (typically) as a percentage of the advance e.g. 5% of the loan.
• A capped rate; where similar to a fixed rate, the interest rate cannot rise above the cap but can vary beneath the cap. Sometimes there is a collar associated with this type of rate which imposes a minimum rate. Capped rate are often offered over periods similar to fixed rates, e.g. 2, 3, 4 or 5 years.

To make matters more confusing these rates are often combined: For example, 4.5% 2 year fixed then a 3 year tracker at BOE rate plus 0.89%.

With each incentive the lender may be offering a rate at less than the market cost of the borrowing. Therefore, they typically impose a penalty if the borrower repays the loan; this used to be called a redemption penalty or tie-in, however since the onset of Financial Services Authority regulation they are referred to as an early repayment charge.

UK Mortgage Process

UK lenders usually charge a valuation fee, which pays for a chartered surveyor to visit the property and ensure it is worth enough to cover the mortgage amount. This is not a full survey so it may not identify all the defects that a house buyer needs to know about. Also, it does not usually form a contract between the surveyor and the buyer, so the buyer has no right to sue if the survey fails to detect a major problem. For an extra fee, the surveyor can usually carry out a building survey or a (cheaper) "homebuyers survey" at the same time.

Guide to buying in the UK from the Royal Institution of Chartered Surveyors.

Glossary of UK mortgage terminology

• Repayment mortgage - A mortgage repayment method where the capital and interest is repaid.
• Endowment mortgage - A mortgage repayment method where the capital is repaid by one or more endowment policies at the end of the mortgage term.
• PEP mortgage or ISA mortgage - an interest only mortgage where the capital is repaid with the proceeds of a PEP or ISA at the end of the mortgage term. (Note: PEPs are no longer available to new investors).
• Interest-only mortgage where the capital is not repaid.
• Pension mortgage where the tax-free cash lump sum of a personal pension scheme is used to repay an interest-only mortgage at retirement.
• Buy to let mortgage - a semi-commercial mortgage on residential property let to tenants.
• Right to buy
• Let and buy mortgage
• Flexible mortgage
• Adverse credit mortgage
• Self-cert mortgage
• Non-status mortgage
• Deferred interest mortgage
• Higher lending fee
• Early repayment charge
• 100% mortgage
• Negative equity
• Offset Mortgage

Islamic mortgages

Islamic Sharia law prohibits the payment or receipt of interest, which means that practising Muslims cannot use conventional mortgages. However, real estate is far too expensive for most people to buy outright using cash: Islamic mortgages solve this problem by having the property change hands twice. In one variation, the bank will buy the house outright and then act as a landlord. The homebuyer, in addition to paying rent, will pay a contribution towards the purchase of the property. When the last payment is made, the property changes hands.

An alternative scheme involves the bank reselling the property according to an installment plan, at a price higher than the original price.

In the United Kingdom, HSBC Bank plc was the first major bank to offer Islamic mortgages.