Mortgage

A legal document by which the owner (i.e., the buyer) transfers to the lender an interest in real estate to secure the repayment of a debt, evidenced by a mortgage note. When the debt is repaid, the mortgage is discharged, and a satisfaction of mortgage is recorded with the register or recorder of deeds in the county where the mortgage was recorded. Because most people cannot afford to buy real estate with cash, nearly every real estate transaction involves a mortgage.

The party who borrows the money and gives the mortgage (the debtor) is the mortgagor; the party who pays the money and receives the mortgage (the lender) is the mortgagee. Under early English and U.S. law, the mortgage was treated as a complete transfer of title from the borrower to the lender. The lender was entitled not only to payments of interest on the debt but also to the rents and profits of the real estate. This meant that as far as the borrower was concerned, the real estate was of no value, that is, "dead," until the debt was paid in full—hence the Norman-English name "mort" (dead), "gage" (pledge).

The mortgage must be executed according to the formalities required by the laws of the state where the property is located. It must describe the real estate and must be signed by all owners, including non-owner spouses if the property is a homestead. Some states require witnesses as well as acknowledgement before a NOTARY PUBLIC.

The mortgage note, in which the borrower promises to repay the debt, sets out the terms of the transaction: the amount of the debt, the mortgage due date, the rate of interest, the amount of monthly payments, whether the lender requires monthly payments to build a tax and insurance reserve, whether the loan may be repaid with larger or more frequent payments without a prepayment penalty, and whether failing to make a payment or selling the property will entitle the lender to call the entire debt due.

State courts have devised varying theories of the legal effect of mortgages: Some treat the mortgage as a conveyance of the title, which can be defeated on payment of the debt; others regard it as a lien, entitling the borrower to all of the rights of ownership, as long as the terms of the mortgage are observed. In California a deed of trust to a trustee who holds title for the lender is the preferred security instrument.

At COMMON LAW, if the borrower failed to pay the debt in full at the appointed time, the borrower suffered a complete loss of title, however long and faithfully the payments had been made.

Courts of EQUITY, which were originally ecclesiastical courts, had the authority to decide cases on the basis of moral obligation, fairness, or justice, as distinguished from the law courts, which were bound to decide strictly according to the common law. Equity courts softened the harshness of the common law by ruling that the debtor could regain title even after default, but before it was declared forfeited, by paying the debt with interest and costs. This form of relief is known as the equity of redemption.

Nowadays, nearly all states have enacted statutes incorporating the equity of redemption, and many also have enacted periods of redemption, specifying lengths of time within which the borrower may redeem. Although some debtors, or mortgagors, are able to avoid foreclosure through the equity of redemption, many are not, because redeeming means coming up with the balance of the mortgage plus interest and costs, something that a financially troubled debtor might not be able to accomplish. However, because foreclosure upends the agreement between mortgagor and mortgagee and creates burdens for both parties, lenders are often willing to work with debtors to help them through a period of temporary difficulty. Debtors who run into problems meeting their mortgage obligations should speak to their lender about developing a plan to avert foreclosure.

Failure to redeem results in foreclosure of the borrower's rights in the real estate, which is then sold by the county sheriff at a public fore-closure sale. At a foreclosure sale, the lender is the most frequent purchaser of the property.

If the bid at the sale is less than the debt, even if it is for fair market value, the lender may be granted a deficiency judgment for the balance of the debt against the debtor, with the right to resort to other assets or income for its collection.

Often other creditors bid at the sale to protect their interest as judgment creditors, second mortgagees, or mechanic's lien claimants. All such persons must be notified of the foreclosure suit and must be given a right to bid at the sale to protect their claims. Similar protections are afforded transactions involving deeds of trust.

A fixed-rate mortgage carries an interest rate that will be set at the inception of the loan and will remain constant for the length of the mortgage. A 30-year mortgage will have a rate that is fixed for all 30 years. At the end of the 30th year, if payments have been made on time, the loan is fully paid off. To a borrower, the advantage is that the rate will remain constant, and the monthly payment will remain the same throughout the life of the loan. The lender is taking the risk that interest rates will rise and that it will carry a loan at below-market interest rates for some or part of the 30 years. Because of this risk, there is usually a higher interest rate on a fixed-rate loan than the initial rate and payments on adjustable rate or balloon mortgages. If the rates fall, homeowners may pay off the loan by refinancing the house at the then-lower interest rate.

An adjustable-rate mortgage (ARM) provides a fixed initial interest rate and a fixed initial monthly payment for a short period of time. With an ARM, after the initial fixed period, which can be anywhere from six months to six years, both the interest rate and the monthly payments adjust on a regular basis to reflect the then-current market interest. Some ARMs may be subject to adjustment every three months, while others may be adjusted once per year. Moreover, some ARMs limit the amount that the rates may change. While an ARM usually carries a lower initial interest rate and a lower initial monthly payment, the purchaser is taking the risk that rates may rise in the future.

An alternative form of financing, usually a last resort for those who do not qualify for other mortgages, is called owner financing or owner carryback. The owner finances or "carries" all or part of the mortgage. Owner financing often involves balloon mortgage payments, as the monthly payments are frequently interest-only. A balloon mortgage has a fixed interest rate and a fixed monthly payment, but after a fixed

A sample plain-language mortgage note

period of time, such as five or ten years, the whole balance of the loan becomes due at once, meaning that the buyer must either pay the balloon loan off in cash or refinance the loan at current market rates.

A home-equity loan is usually used by homeowners to borrow some of the equity in the home. This may raise the monthly housing payment considerably. More and more lenders are offering home-equity lines of credit. The interest might be tax-deductible because the debt is secured by a home. A home-equity line of credit is a form of revolving credit secured by a home. Many lenders set the credit limit on a home-equity line by taking a percentage of the home's appraised value and subtracting from that the balance owed on the existing mortgage. In determining the credit limit, the lender will also consider other factors to determine the homeowner's ability to repay the loan. Many home-equity plans set a fixed period during which money may be borrowed. Some lenders require payment in full of any outstanding balance at the end of the period.

Home-equity lines of credit usually have variable, rather than fixed, interest rates. The variable rate must be based on a publicly available index such as the prime rate published in major daily newspapers or a U.S. Treasury bill rate. The interest rate for borrowing under the home-equity line will change in accordance with the index. Most lenders set the interest rate at the value of the index at a particular time plus a margin, such as 3 percentage points. The cost of borrowing is tied directly to the value of the index. Lenders sometimes offer a temporarily discounted interest rate for a home-equity line. This is a rate that is unusually low and that may last for a short introductory period of merely a few months.

The costs of setting up a home-equity line of credit typically include a fee for a property appraisal, an application fee, fees for attorneys, title search, mortgage preparation and filing fees, property and title insurance fees, and taxes. There also might be recurring maintenance fees for the account, or a transaction fee every time there is a draw on the credit line. It might cost a significant amount of money to establish the home-equity line of credit, although interest savings often justify the cost of establishing and maintaining the line.

The federal TRUTH IN LENDING ACT, 15 U.S.C.A. §§ 1601 set. seq., requires lenders to disclose the important terms and costs of their home-equity plans, including the APR, miscellaneous charges, the payment terms, and information about any variable-rate feature. If the home involved is a principal dwelling, the Truth in Lending Act allows three days from the day the account was opened to cancel the credit line. This right allows the borrower to cancel for any reason by informing the lender in writing within the three-day period. The lender then must cancel its security interest in the property and return all fees.

A second mortgage provides a fixed amount of money that is repayable over a fixed period. In most cases, the payment schedule calls for equal payments that will pay off the entire loan within the loan period. A second mortgage differs from a home-equity loan in that it is not a line of credit, but rather a more traditional type of loan. The traditional second-mortgage loan takes into account the interest rate charged plus points and other finance charges. The annual percentage rate for a home-equity line of credit is based on the periodic interest rate alone. It does not include points or other charges.

A reverse mortgage works much like a traditional mortgage, only in reverse. It allows homeowners to convert the equity in a home into cash. A reverse mortgage permits retired homeowners who own their home and have paid all of their mortgage to borrow against the value of their home. The lender pays the equity to the homeowner in either payments or a lump sum. Unlike a standard home-equity loan, no repayment is due until the home is no longer used as a principal residence, a sale of the home, or the death of the homeowner.

A deed of trust is similar to a mortgage, with one important exception: If the borrower breaches the agreement to pay off the loan, the foreclosure process is typically much quicker and less complicated than the formal mortgage-foreclosure process. While a mortgage involves a relationship between the borrower/homeowner and the bank/lender, a deed of trust involves the homeowner, the lender, and a title insurance company. The title insurance company holds legal title to the real estate until the loan is paid in full, at which time the company transfers the property title to the homeowner.

Subdivision or condominium-development mortgages that cover a large tract of land are blanket mortgages. A blanket mortgage makes possible the sale of individual lots or units, with the proceeds applied to the mortgage, and partial release of the mortgage recorded to clear the title for that lot or unit.

Construction mortgages need special treatment depending on state construction-lien law. Often the loan proceeds are placed in escrow with title insurance companies to make certain that the mortgage remains a first lien, with priority over contractors' construction liens.

Open-end mortgages make possible additional advances of money from the lender without the necessity of a new mortgage.

The time of repayment may be extended by a recorded extension of mortgage. Other real estate may be added to the mortgage by a spreading agreement. Mortgaged real estate may be sold, with the buyer taking either "subject to" or by "assuming" the mortgage. In the former case, the buyer acknowledges the existence of the mortgage and, upon default, may lose the title. By assuming the mortgage, the buyer promises to repay the debt and may be personally liable for a deficiency judgment if the sale brings less than the debt.

Lenders regularly assign mortgages to other investors. Assignments with recourse are guarantees by the one who assigns the mortgage that that party will collect the debt; those WITHOUT RECOURSE do not contain such guarantees. Assignments with recourse usually involve lower-risk properties or those of relatively stable or rising value. Assignments without recourse tend to involve riskier properties. Mortgages assigned without recourse are often sold at a price discounted well below their market value.

Before the Great Depression of the 1930s, most mortgages were "straight" short-term mortgages, requiring payments of interest and lump-sum principal, with the result that when incomes dropped, many borrowers lost their properties. That risk is minimized today because commercial lenders take fully amortized mortgages, in which part of the periodic payment

applies first to interest and then to principal, with the balance reduced to zero at the end of the term.

Several agencies of the federal government have assisted the mortgage market by infusion of capital and by guarantees of repayment of mortgages. The Federal Housing Administration made possible purchases of real estate at low interest rates and with low down payments. The VETERANS AFFAIRS DEPARTMENT (VA) also guarantees home loans to certain veterans on favorable terms. Both agencies contributed greatly to the growth of the housing market after WORLD WAR II. During the late 1950s, private corporations began insuring repayment of conventional mortgages.

The GOVERNMENT NATIONAL MORTGAGE ASSOCIATION (Ginnie Mae), created by the U.S. government in 1968, makes possible trading in mortgages by investors by guaranteeing mortgage-backed SECURITIES.

The FEDERAL NATIONAL MORTGAGE ASSOCIATION (Fannie Mae) is a private corporation, chartered by the U.S. government, that bolsters the supply of funds for home mortgages by buying mortgages from banks, insurance companies, and savings and loans.

Inflation in the 1970s made long-term fixed-rate mortgages less attractive to lenders. In response, lenders devised three types of mortgage loans that enable the rate of interest to vary in case of rises in rates: the variable-rate mortgage, graduated-payment mortgage, and the adjustable-rate mortgage. These mortgages are offered at initial interest rates that are somewhat lower than those for 20- to 30-year fixed-rate mortgages.

Home-equity loans are typically second mortgages to the holder of the first mortgage, advancing funds based on a percentage of the owner's equity; that is, the amount by which the value of the real estate exceeds the first mortgage balance.