A mortgage is a transfer of an interest in real estate as security for the repayment of a loan. A typical mortgage transaction involves a home purchaser borrowing money from a lender or mortgage company and 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, and have it sold to reduce the 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 and the debt owed.
This article provides mortgage basics for first-time buyers and those who need a refresher. See Mortgage and Loan Basics for additional articles and resources.
Mortgage Basics: The Loan Process
A borrower (or 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) and in some cases pay a nonrefundable upfront fee.
The lender conducts a risk evaluation to determine whether a mortgage loan will be granted. In the risk analysis, the lender evaluates both the borrower's financial position, through there credit score and debt to income ratio, private mortgage insurance (PMI) and closing costs, against the 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, monthly mortgage payments, interest rates, and other pertinent conditions.
Because the commitment normally contains terms and conditions not found in the loan application, it typically 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 usually bare interest at a fixed annual percentage rate for the life of the loan, usually a period of fifteen or thirty years.
The interest rate is determined by the prevailing market conditions. A lender may increase its yield beyond the stated interest rate by requiring the borrower to pay "points" at the time the loan is made. One point equals one percent of the loan amount. It is beneficial for the borrower to pay points in order to reduce the interest rate over the term of the loan.
Mortgage Basics: Key Phrases
Adjustable rate mortgages (ARMs) are determined as the mortgage interest rate rises and falls over the term of the loan in accordance with prevailing market conditions. The parties may agree to hedge against extreme interest rate fluctuations by establishing ceiling and floor limits with this type of mortgage.
A balloon mortgage, less common, exists when a substantial payment or lump sum is required at the end of the loan term to cover the unamortized loan principal.
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, failure to insure the property or pay property taxes.
Finally, construction difficulties or physical damage or destruction to the property by the mortgagor, constituting "waste," can also be considered an event of default.
Mortgages contain an acceleration clause providing that any default makes the debt payable on demand, making the entire debt due immediately.
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.
When the homeowners sell or transfer the mortgaged property, the lender demands satisfaction of its mortgage before any sale or transfer of interest occurs.
Another option, the lender may consent to the transaction conditioned on the grantee's assumption of the mortgage and payment obligation, possibly also with a transfer fee and/or an increased interest rate.
If you have additional questions pertaining to mortgage basics or more advanced topics, ask your agent or speak with a real estate attorney.
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