Mortgage Basics

A mortgage is a transfer of an interest in real estate as security for the repayment of a loan. It allows a buyer to finance the purchase of their home through a repayment period of time. A typical mortgage transaction involves:

• A home purchaser borrowing money from a lender or mortgage company
• Entering into a written agreement, so that the real estate is collateral for the loan

If the home buyer defaults on the loan, the lender is entitled to foreclose on the real estate. They may have it sold to reduce or eliminate the outstanding loan amount. Depending on the terms of the mortgage, the lender may pursue the homeowner for payment of any deficiency between:

• The real estate sale proceeds
• The debt owed

This article provides mortgage basics and answers to frequently asked questions (FAQ) for first-time buyers and those who need a refresher. For additional articles and resources, check out FindLaw's Mortgage and Loan Basics section.

Mortgage Basics: The Loan Process

A borrower (mortgagor) obtains a mortgage loan through a process of application and commitment. The borrower initiates the mortgage process by submitting a mortgage application to the lender (mortgagee). In some cases, the borrower may pay a nonrefundable upfront fee.

The lender conducts a risk evaluation to determine whether a mortgage loan will be granted. In the risk analysis phase, the lender evaluates:

• The borrower's financial position, debt-to-income ratio (DTI), and loan-to-value ratio (LTV)
• Credit score, existing personal loans, credit card debt, potential bad credit, and credit lines
• The appraised value and market value of a property
• Private mortgage insurance (PMI) and closing costs, against the property value of the real estate

If the lender determines the risk to be acceptable, the lender will issue a loan commitment detailing:

• The loan amount and down payment
• Monthly mortgage payments (installment schedule)
• Lower or higher Interest rates
• Other pertinent conditions

Because the commitment often contains terms and conditions not found in the loan application, it constitutes a counteroffer to make a loan. When the borrower accepts the commitment, a binding contract for a mortgage home loan is created.

Residential mortgage loans often bear interest at a fixed annual percentage rate for the life of the loan. A period of fifteen or thirty years with a fixed interest rate is common for mortgages. Interest paid on a mortgage may be tax deductible.

The interest rate is determined by the prevailing market conditions. A lender may increase its yield beyond the stated interest rate. They can do this by requiring the borrower to pay points at the time the loan is made. One point equals 1% of the loan amount. It is beneficial for the borrower to pay points to reduce the interest rate over the term of the loan.

ARMs, HELOCs, and Balloon Mortgages

Adjustable rate mortgages (ARMs) are determined as the mortgage interest rate rises and falls over the term of the loan. This occurs in accordance with prevailing market conditions which affect variable interest rates. The parties may agree to hedge against extreme interest rate fluctuations. They can do this by establishing ceiling and floor limits with this type of mortgage.

When you need to take on home improvement projects, you may consider a home equity product such as a:

• Home equity loan
• Home equity line of credit (HELOC)

As second mortgages, these financial products allow you to tap into the value of your home. Home equity loan rates may be higher because they are junior to your current mortgage. You may have built up an amount of equity in your home beyond the size of your existing mortgage. Your first mortgage covers the original purchase, while the home equity loan works toward your home renovations.

An interest-only balloon mortgage is a less common type of loan. A substantial loan payment or lump sum is required at the end of the loan term to cover the unamortized loan balance. Borrowers should be very careful to anticipate the amount of money needed to clear the mortgage balance.

Mortgage Default

Default occurs when the mortgagor fails to perform an obligation secured by the mortgage. Common causes of default are the mortgagor's failure to:

• Make monthly mortgage payments
• Insure the property
• Pay property taxes
• Follow a material term in the loan agreement, such as refraining from using a primary residence as a rental investment property

Construction difficulties or physical damage are also factors. They may amount to destruction of the property by the mortgagor. This constitutes waste and can also be considered an event of default.

To cure a default and improve their financial situations, borrowers may consider:

• Refinancing monthly payments with a credit union to get lower interest rates
• Cash-out refinance options
• Debt consolidation

There are other options as well. If you're uncertain what to do, consider speaking with an accountant, financial planner, or real estate lawyer.

Mortgage Acceleration

Mortgages contain an acceleration clause providing that any default makes the debt payable on demand, making the entire debt due at once.

Residential mortgage lenders are required by law to provide notice of debt acceleration and the opportunity for the borrower to cure the default. In most states, filing foreclosure proceedings is considered notice to the borrower.

Mortgages provide for payment on demand in the event the borrower transfers any interest in the mortgaged property without the lender's consent.

Sale or Transfer of Property

When homeowners sell or transfer a mortgaged property, the lender demands satisfaction of its mortgage before any sale or transfer of interest occurs.

As another option, the lender may consent to the transaction conditioned on the grantee's assumption of the mortgage and payment obligation, with a possible transfer fee and/or an increased interest rate.

Consult a Lawyer for Legal Advice

You may have additional questions pertaining to mortgage basics or more advanced topics. A real estate attorney can review your mortgage documents. They can provide you with feedback on confusing legal terms. They may also be able to negotiate with your bank in case you’re facing any legal challenges.