Home Equity Loan
Mortgage
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 absolute 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).
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 borrower 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:
(a) blanket loan
(b) bridge loan
(c) budget loan
(d) commercial loan
(e) deed of trust
(f) equity loan
(g) hard money loan
(h) package loan
(i) participation mortgage
(j) reverse mortgage
(k) repayment mortgage
(l) seasoned mortgage
(m) term loan or interest-only loan
(n) wraparound mortgage
(o) 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.
(a) credit report
(b) 1003 -- Uniform Residential Loan Application
(c) 1004 -- Uniform Residential Appraisal Report
(d) 1005 -- Verification Of Employment (VOE)
(e) 1006 -- Verification Of Deposit (VOD)
(f) 1007 -- Single Family Comparable Rent Schedule
(g) 1008 -- Transmittal Summary
(h) Copy of deed of current home
(i) federal income tax records for last two years
(j) Verification Of Mortgage (VOM) or Verification Of Payment (VOP)
(k) Borrower's Authorization
(l) Purchase Sales Agreement
(m) 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.
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) 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.
(b) 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.
(c) 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.
(d) 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.
Self Cert Mortgage
The high street banks usually use salaries declared on wage slips to work out
your annual income and they usually lend you a multiple of your annual income
(usually 3.5).
Self Certification Mortgage better known as "self cert mortgages", are mortgages
that are available to self employed people that have a deposit to buy a house
but lack the sufficient documentation to prove their income.
Self cert mortgages have a two disadvantages one of which is that the interest
rates are usually higher than they normally are and the second is that they only
finance 75% [Loan To Value] of a property.
100% Mortgages
Normally when a bank lends a customer money they want to protect their money as
much as possible, they do this by asking the borrower to pay a certain
percentage of the loan in the form of a deposit.
100% mortgages are mortgages that require no deposit (100% loan to value).
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.
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.
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.