mortgage

mortgage

[mawr-gij]
mortgage, in law, device for protecting a creditor by giving him an interest in property of his debtor. In common law a mortgage was a conditional sale; i.e., the mortgagor (debtor) sold realty (real property mortgage) or personal property (chattel mortgage), but if the debtor paid the debt by a certain time the sale was voided. The mortgagee (creditor) held legal title, the mortgagor equitable title; both estates were salable. Today Great Britain and a majority of states in the United States view mortgages as liens on property. The practical result under the two systems is the same. If the mortgagor does not pay the debt, the creditor seeks a court-ordered sale of the property (foreclosure), and the debt is paid out of the proceeds. During economic depressions many jurisdictions enact temporary mortgage moratorium statutes that give courts the discretionary power to refuse to foreclose mortgages. In a reverse mortgage, a homeowner borrows against the value of a house to receive a line of credit or monthly payments. Reverse mortgages are used by elderly homeowners as a way of obtaining cash, and normally the loan is paid off when the homeowner dies (or sells the property).

In Anglo-American law, the method by which a debtor (mortgagor) conveys an interest in property to a creditor (mortgagee) as security for the payment of a money debt. The modern mortgage has its roots in medieval Europe. Originally, the mortgagor gave the mortgagee ownership of the land on the condition that the mortgagee would return it once the mortgagor's debt was paid off. Over time, it became the practice to let the mortgagor remain in possession of the land; it then became the mortgagor's right to remain in possession of the land so long as there was no default on the debt.

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A mortgage is the pledging of a property to a lender as a security for a mortgage loan. While a mortgage in itself is not a debt, it is evidence of a debt. It is a transfer of an interest in land, from the owner to the mortgage lender, on the condition that this interest will be returned to the owner of the real estate when the terms of the mortgage have been satisfied or performed. In other words, the mortgage is a security for the loan that the lender makes to the borrower.

The term comes from the Old French "dead pledge," apparently meaning that the pledge ends (dies) either when the obligation is fulfilled or the property is taken through foreclosure.

In most jurisdictions mortgages are strongly associated with loans secured on real estate rather than other property (such as ships) and in some jurisdictions only land may be mortgaged. Arranging a mortgage is seen as the standard method by which individuals and businesses can purchase residential and commercial real estate without the need to pay the full value immediately. See mortgage loan for residential mortgage lending, and commercial mortgage for lending against commercial property.

The measurement of a mortgage with regards to cost to the borrower can be measured by Annual Percentage Rate (APR) or many other formulas for true cost such as Lender Police Effective Annual Rate (LPEAR).

In many countries it is normal for home purchases to be funded by a mortgage. In countries where the demand for home ownership is highest, strong domestic markets have developed, notably in Spain, the United Kingdom, Australia and the United States.

Participants and variant terminology

Legal systems, while having some concepts in common, employ different terminology. However, in general, a mortgage of property involves the following parties.

Mortgage lender

Mortgagee is the legal term for the mortgage lender. The main function of the mortgage is to provide security to the lender. Given the large sum of money involved in financing a property, a mortgage lender will usually want security for the loan that will provide a claim upon that security and will take precedence over other creditors. A mortgage accomplishes this security.

The lender loans the money and registers the mortgage against the title to the property. The borrower gives the lender the mortgage as security for the loan, receives the funds, makes the required payments and maintains possession of the property. The borrower has the right to have the mortgage discharged from the title once the debt is paid. If the mortgagor fails to repay the loan according to the conditions set forth by the lender, then the mortgagee reserves the right to foreclose on the property.

Borrower

Mortgagor is the legal term for the borrower, who owes the obligation secured by the mortgage, and may be multiple parties. Generally, the debtor must meet the conditions of the underlying loan or other obligation and the conditions of the mortgage. Otherwise, the debtor usually runs the risk of foreclosure of the mortgage by the creditor 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.

Most buyers of real property would have difficulty saving enough money to make an outright purchase of real estate. The use of debt increases a buyer's ability to buy through a combination of down payment and debt. As a result a real estate transaction seldom occurs without borrowers relying on borrowed funds.

Borrowing for investment purposes

Aside from the absence of large amount of available money, there are several reasons why an investor (including a buyer of real estate) might borrow funds. Some of these include:

  • To diversify investments and reduce overall risk by using only part of the available funds for any one investment
  • To invest the borrowed funds at a higher rate of interest (yield) than the borrowing rate; for example, a sum is borrowed at an annual interest rate of 7% and used to invest in a project that returns 10%
  • To free up equity for other purposes; for example, a commercial enterprise may prefer to use funds to purchase inventory or equipment instead of investing only in land and buildings.
  • To obtain a tax benefit. In some countries (such as Canada), mortgage interest is not tax deductible, but loans made for investment purposes are.

Other participants

Because of the complicated legal exchange, or 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.

Because of 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, in civil law jurisdictions, referred to as hypothecation, which may make use of the services of a hypothecary to assist in the hypothecation.

Default on Subdivided Property

When a tract of land is purchased with a mortgage and then split up and sold off, then the "inverse order of alienation rule" applies to find out who will be liable for the default.

Basically, when a mortgaged tract of land is split up and sold off, then upon default, the mortgagee forecloses and proceeds against lands still owned by the mortgagor, then liability attaches in a backward fashion, or in an 'inverse order' as they were sold. So if A acquires a lot by mortgage then splits up the lot into three 1 acre lots (A, B, and C), and sells lot B to X, and then lot C to Y, retaining lot A for himself then, upon default, the mortgagee will go after lot A, the mortgagor, and if that sale does not satisfy the default, then the owner of lot C will be liable, then the owner of lot B. The idea is that the first purchaser should have more equity and subsequent purchasers receive a diluted share.

Legal aspects

Mortgages may be legal or equitable. Furthermore, a mortgage may take one of a number of different legal structures, the availability of which will depend on the jurisdiction under which the mortgage is made. Common law jurisdictions have evolved two main forms of mortgage: the mortgage by demise and the mortgage by legal charge.

Mortgage by demise

In a mortgage by demise, the mortgagee (the lender) becomes the owner of the mortgaged property until the loan is repaid or other mortgage obligation fulfilled in full, a process 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.

Mortgages by demise were the original form of mortgage, and continue to be used in many jurisdictions, and in a small minority of states in the United States. Many other common law jurisdictions have either abolished or minimised the use of the mortgage by demise. For example, in England and Wales this type of mortgage is no longer available, by virtue of the Land Registration Act 2002.

Mortgage by legal charge

In a mortgage by legal charge or technically "a charge by deed expressed to be by way of legal mortgage", 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 most common in the United States and, since the Law of Property Act 1925, it has been the usual form of mortgage in England and Wales (it is now the only form see above).

In Scotland, the mortgage by legal charge is also known as standard security.

In Pakistan, the mortgage by legal charge is most common way used by banks to secure the financing. It is also known as registered mortgage. After registration of legal charge, the bank's lien is recorded in the land register stating that the property is under mortgage and cannot be sold without obtaining an NOC (No Objection Certificate) from the bank.

Equitable mortgage

In an equitable mortgage the lender is secured by taking possession of all the original title documents of the property and by borrower's signing a Memorandum of Deposit of Title Deed (MODTD). This document is an undertaking by the borrower that he/she has deposited the title documents with the bank with his own wish and will, in order to secure the financing obtained from the bank.

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 met usually, but not necessarily, the repayment of a debt to the original landowner. Hence the word "mortgage" (a legal term in French meaning "dead pledge"). The debt was absolute in form, and unlike a "live pledge" was not conditionally dependent on its repayment solely from raising and selling crops or livestock or simply giving the crops and livestock raised on the mortgaged land. 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 in 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 lender was in 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's 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.

Foreclosure and non-recourse lending

In most jurisdictions, a lender may foreclose on the mortgaged property if certain conditions principally, non-payment of the mortgage loan apply. Subject to local legal requirements, the property may then be sold. Any amounts received from the sale (net of costs) are applied to the original debt.

In some jurisdictions, mortgage loans are non-recourse loans: if the funds recouped from sale of the mortgaged property are insufficient to cover the outstanding debt, the lender may not have recourse to the borrower after foreclosure. In other jurisdictions, the borrower remains responsible for any remaining debt, through a deficiency judgment.

Specific procedures for foreclosure and sale of the mortgaged property almost always apply, and may be tightly regulated by the relevant government. In some jurisdictions, foreclosure and sale can occur quite rapidly, while in others, foreclosure may take many months or even years. In many countries, the ability of lenders to foreclose is extremely limited, and mortgage market development has been notably slower.

At the start of 2008, 5.6% of all mortgages in the United States were delinquent. By the end of the first quarter that rate had risen, encompassing 6.4% of residential properties. This number did not include the 2.5% of homes in foreclosure.

Mortgages in the United States

Types of mortgage instruments

Two types of mortgage instruments are commonly used in the United States: the mortgage (sometimes called a mortgage deed) and the deed of trust.

The mortgage

In all but a few states, a mortgage creates a lien on the title to the mortgaged property. Foreclosure of that lien almost always requires a judicial proceeding declaring the debt to be due and in default and ordering a sale of the property to pay the debt.

The deed of trust

The deed of trust is a deed by the borrower to a trustee for the purposes of securing a debt. In most states, it also merely creates a lien on the title and not a title transfer, regardless of its terms. It differs from a mortgage in that, in many states, it can be foreclosed by a non-judicial sale held by the trustee. It is also possible to foreclose them through a judicial proceeding.

Most "mortgages" in California are actually deeds of trust. The effective difference is that the foreclosure process can be much faster for a deed of trust than for a mortgage, on the order of 3 months rather than a year. Because the foreclosure does not require actions by the court the transaction costs can be quite a bit less.

Deeds of trust to secure repayments of debts should not be confused with trust instruments that are sometimes called deeds of trust but that are used to create trusts for other purposes, such as estate planning. Though there are superficial similarities in the form, many states hold deeds of trust to secure repayment of debts do not create true trust arrangements.

Mortgage lien priority

Except in those few states in the United States that adhere to the title theory of mortgages, either a mortgage or a deed of trust will create a mortgage lien upon the title to the real property being mortgaged. The lien is said to "attach" to the title when the mortgage is signed by the mortgagor and delivered to the mortgagee and the mortgagor receives the funds whose repayment the mortgage secures. Subject to the requirements of the recording laws of the state in which the land is located, this attachment establishes the priority of the mortgage lien with respect to most other liens on the property's title. Liens that have attached to the title before the mortgage lien are said to be senior to, or prior to, the mortgage lien. Those attaching afterward are said to be junior or subordinate. The purpose of this priority is to establish the order in which lien holders are entitled to foreclose their liens in an attempt to recover their debts. If there are multiple mortgage liens on the title to a property and the loan secured by a first mortgage is paid off, the second mortgage lien will move up in priority and become the new first mortgage lien on the title. Documenting this new priority arrangement will require the release of the mortgage securing the paid off loan.

Further reading

  • Rhodes, Trevor. American Mortgage: Everything U Need to Know... about Financing a Home. 444 pages. McGraw-Hill, June, 2008. ISBN 0-07-159054-4

See also

Notes and references

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