A mortgage ( Law French for "dead pledge") is a device used to create a lien on real estate by contract . It is used as a method by which individuals or businesses can buy residential or commerical property without paying the full value upfront. The borrower (called the mortgagor) uses a mortgage to pledge real property to the lender (called the mortgagee) as security against the debt (also called hypothecation ) for the rest of the value of the property. In legal terms, the creation of a mortgage gives the legal title of the land to the mortgagee and an equitable title (called "equity of redemption") to the mortgagor. The legal title, however, only exists as a security for a debt and does not convey any title or powers associated real property.
The mortgage instrument contains two parts:
- the mortgage, which is the pledge
- the note , which is the actual evidence of the debt and promise to repay (sometimes called a promissory note ).
To protect the lender, a mortgage is recorded in the public records creating a lien (when there are multiple liens, order of recording determines priority). 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 the lien of the mortgage is prior to anyone else's claim.
At common law , a mortgage was a conveyance for 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.
In many U. S. states , however, a mortgage has been converted by statute to a device for creating a security interest in land. When the landowner fails to perform on the obligation secured by the mortgage, the mortgage holder may file a foreclosure to cause the property to be sold at auction, usually by the sheriff .
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 " and " Freddie Mac " (also known as the GSEs or government sponsored entities ) to foster mortgage lending and thus to encourage home ownership and construction.
Levels and flows
In 2003, total U.S. residential mortgage production reached a record level of $3.8 trillion through record low interest rates orchestrated by Alan Greenspan .
- Adjustable Rate Mortgage (ARM)
- 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 or a "C-" in private 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
(LTV) - Loan Amount / Value of property.
- Combined loan to value (CLVT ). All loans outstanding (i.e. 1st & 2nd) / Value of property.
- No Income No Asset (NINA)
- 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.
- Quit Claim Deed (QCD)
- 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 loan types
In a FRM, the interest rate, and hence monthly payment, remains fixed for the life (or term) of the loan. In the US, the term is usually for 10, 15, 20, or 30 years. In the UK the fixed term can be as short as five years, after which the loan reverts to a variable rate (which makes the loan an ARM).
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 US include the Prime Rate, the LIBOR, and the Treasury Index ("T-Bill"). Other indexes like COFI, 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:
- term loan or interest-only loan
- equity loan
- blanket loan
- package loan
- wraparound mortgage
- seasoned mortgage
- reverse mortgage
- budget loan
- deed of trust
- bridge loan
- hard money loan
Costs involved in a mortgage
Lenders may charge various fees when giving a mortgage to a mortgagee. These include entry fees, exit fees, administration fees and lenders mortgage insurance .
Fixed rate mortgage calculations
First the nomenclature.
I - The stated interest rate, for example, 5%/year. This is not the APR (annualized percentage rate).
m - The number of periods in the time frame of I. I is usually based on a year but it could be based on any amount of time.
i - The interest rate for the compounding period which is needed for the calculation. For example, a real property mortgage is usually based on a monthly period. In this case i=I*1/12 where I is based on the normal yearly period. In general i=I/m. Also I needs to be a decimal not a percent thus it also needs to be divided by 100.
n - The total number of periods or payments. Things like mortgages usually cover multiple years.
B - The balance, for example, the balance remaining on the mortgage at any point in time.
Let B 0 be the original mortgage.
Let B 1 , B 2 , B 3 etc. be the balance after the first, second, third period respectively.
Obviously, one can think of B 0 as the balance after the zeroth period namely the beginning balance.
P - The mortgage payment.
Now lets write down the balances. First the initial balance, the amount of the mortgage.
Now calculate the balance after one period or payment.
During the first period the initial balance has grown by the period interest and has been decreased by the first payment. Similarly
After n periods or payments we have
B n is set equal to zero. When the mortgage is paid off the balance is zero. Now one can solve for P the payment. Rearranging gives:
Solving for P gives:
The payment can be readily calculated to the penny with a spread sheet or scientific calculator.
Note: B 0 is just a simple multiplier. Therefore one can do the calculation for a unit of currency such as a dollar and then multiply the result by the amount of the loan. In essence B 0 is just a scale factor . For example think of the loan amount as my dollar where my dollar is just a currency whose exchange rate is just the loan amount difference.
Now lets do some calculations. Mortgages are usually for 10, 15, 20 or 30 years. Interest rates used to be around 9%/year and today around 6%/year. For all calculations B 0 = 1
years, n, (1 + i)^n, P, nP for i = .09/12 = .0075
10 120 2.451357078 .012667577 1.520109285
15 180 3.838043267 .010142665 1.8256797
20 240 6.009151524 .008997259559 2.15934216
30 360 14.73057612 .00804622617 2.89664136
years, n, (1 + i)^n, P, nP for i = .06/12 = .005
10 120 1.819396734 .0110205 1.332246023
15 180 2.454093562 .008438568281 1.51894224
20 240 3.310204476 .007164310585 1.7194344
30 360 6.022575212 .005995505252 2.158381891
First calculate (1 + i)^n since it occurs in both the numerator and the denominator. Then complete the calculation for the payment P. In the first case, for each dollar of loan the payment is a little over a penny per month. Multiplying the amount of the payment P by the number of payments n gives the total amount paid. In the first case, for each dollar of loan the repayment is a little over a dollar and 82 cents. The 1.82 is also the ratio of the repayment amount to the amount of the loan.
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.
Torrens title registration system
Under the Torrens title registration system of land ownership registration, mortgages and easements are recorded on the title at the central registry, so that any buyer knows for certain whether a block of land is subject to a mortgage or not. This is a simple process, which reduces transaction costs involved in the sale of land.
- Consumer Handbook on Adjustable Rate Mortgages ( http://www.federalreserve.gov/pubs/brochures/arms/arms.pdf ) (US Federal Reserve) ( PDF )
- Property Page UK ( http://www.property-page.co.uk ) . Information about the different mortgage types that are available in the UK.
- Mortgage Calculator with dynamic diagrams ( http://www.karakas-online.de/myServices/mortgage_calculator.php ) . This mortgage calculator can be used to figure out monthly payments of a home mortgage loan. It factors in PMI (Private Mortgage Insurance), town property taxes, and their effect on the total monthly mortgage payment. The calculations are visualized with the aid of two diagrams, displaying the remaining balance and monthly paid interest vs. monthly paid principal respectively, both on a month/money coordinate system.
- Mortgage Loan Links ( http://www.mortgage-loan-links.com ) . A directory of mortgage and loan resources including calculators, global vendor listings, and regional listings.
- Remortgage Advice ( http://www.remortgage-advice.info ) . A site dedicated to providing free information about remortgaging your property.
- Financial Blogs UK ( http://www.clickgofind.com:8080/blogs/index.php?blog=2 ) . Loans News & Resources from The UK and Europe.
- Mortgage Blogs via Bloglines ( http://www.bloglines.com/search?t=1&r=0&q=mortgage )
- Mortgage, Loan and Refinance Information: A Borrower's Guide to Online Resources. ( http://www.noendpress.com/pvachier/mortgage/ )
- Islamic Financing Newspaper Article ( http://www.geocities.com/WestHollywood/Park/6443/Finance/20030902.html )
- The principles of mortgage-financed construction ( http://samvak.tripod.com/nm091.html )
- Home Mortgage Talk ( http://www.homemortgagetalk.com ) . Provides free mortgage-related information and advice.
-  ( http://www.texasmortgagelending.info ) Current Mortgage Interest Rates]
- Mortgage Advice Tips ( http://www.personal-finance-info.com/2005/03/mortgage-advice.html )