Mortgage loan
Encyclopedia
A mortgage loan is a loan
secured
by real property
through the use of a mortgage note
which evidences the existence of the loan and the encumbrance
of that realty through the granting of a mortgage which secures
the loan. However, the word mortgage alone, in everyday usage, is most often used to mean mortgage loan.
A home buyer or builder can obtain financing (a loan) either to purchase or secure against the property from a financial institution, such as a bank
, either directly or indirectly through intermediaries. Features of mortgage loans such as the size of the loan, maturity of the loan, interest rate, method of paying off the loan, and other characteristics can vary considerably.
In many jurisdictions, though not all (Bali, Indonesia
being one exception), it is normal for home purchases to be funded by a mortgage loan. Few individuals have enough savings or liquid funds to enable them to purchase property outright. In countries where the demand for home ownership is highest, strong domestic markets have developed.
The word mortgage is a Law French
term meaning "dead pledge," apparently meaning that the pledge ends (dies) either when the obligation is fulfilled or the property is taken through foreclosure
.
, a mortgage occurs when an owner (usually of a fee simple
interest in realty
) pledges his or her interest (right to the property) as security
or collateral
for a loan. Therefore, a mortgage is an encumbrance
(limitation) on the right to the property just as an easement
would be, but because most mortgages occur as a condition for new loan money, the word mortgage has become the generic term for a loan
secured by such real property
.
As with other types of loans, mortgages have an interest rate and are scheduled to amortize over a set period of time, typically 30 years. All types of real property can be, and usually are, secured with a mortgage and bear an interest rate that is supposed to reflect the lender's risk.
Mortgage lending is the primary mechanism used in many countries to finance private ownership of residential and commercial property (see commercial mortgage
s). Although the terminology and precise forms will differ from country to country, the basic components tend to be similar:
Many other specific characteristics are common to many markets, but the above are the essential features. Governments usually regulate many aspects of mortgage lending, either directly (through legal requirements, for example) or indirectly (through regulation of the participants or the financial markets, such as the banking industry), and often through state intervention (direct lending by the government, by state-owned banks, or sponsorship of various entities). Other aspects that define a specific mortgage market may be regional, historical, or driven by specific characteristics of the legal or financial system.
Mortgage loans are generally structured as long-term loans, the periodic payments for which are similar to an annuity
and calculated according to the time value of money
formulae. The most basic arrangement would require a fixed monthly payment over a period of ten to thirty years, depending on local conditions. Over this period the principal component of the loan (the original loan) would be slowly paid down through amortization
. In practice, many variants are possible and common worldwide and within each country.
Lenders provide funds against property to earn interest income, and generally borrow these funds themselves (for example, by taking deposits or issuing bonds
). The price at which the lenders borrow money therefore affects the cost of borrowing. Lenders may also, in many countries, sell the mortgage loan to other parties who are interested in receiving the stream of cash payments from the borrower, often in the form of a security (by means of a securitization
).
Mortgage lending will also take into account the (perceived) riskiness of the mortgage loan, that is, the likelihood that the funds will be repaid (usually considered a function of the creditworthiness of the borrower); that if they are not repaid, the lender will be able to foreclose and recoup some or all of its original capital; and the financial, interest rate risk
and time delays that may be involved in certain circumstances.
The two basic types of amortized loans are the fixed rate mortgage
(FRM) and adjustable-rate mortgage (ARM) (also known as a floating rate
or variable rate mortgage). In many countries (such as the United States), floating rate mortgages are the norm and will simply be referred to as mortgages. Combinations of fixed and floating rate are also common, whereby a mortgage loan will have a fixed rate for some period, and vary after the end of that period.
The charge to the borrower depends upon the credit risk in addition to the interest rate risk. The mortgage origination and underwriting process involves checking credit scores, debt-to-income, downpayments, and assets. Jumbo mortgages and subprime lending
are not supported by government guarantees and face higher interest rates. Other innovations described below can affect the rates as well.
The loan to value ratio is considered an important indicator of the riskiness of a mortgage loan: the higher the LTV, the higher the risk that the value of the property (in case of foreclosure) will be insufficient to cover the remaining principal of the loan.
(all debt payments, including mortgage payments, as a percentage of income); and various net worth measures. In many countries, credit score
s are used in lieu of or to supplement these measures. There will also be requirements for documentation of the creditworthiness, such as income tax returns, pay stubs, etc; the specifics will vary from location to location.
Some lenders may also require a potential borrower have one or more months of "reserve assets" available. In other words, the borrower may be required to show the availability of enough assets to pay for the housing costs (including mortgage, taxes, etc.) for a period of time in the event of the job loss or other loss of income.
Many countries have lower requirements for certain borrowers, or "no-doc" / "low-doc" lending standards that may be acceptable in certain circumstances.
A standard or conforming mortgage is a key concept as it often defines whether or not the mortgage can be easily sold or securitized, or, if non-standard, may affect the price at which it may be sold. In the United States, a conforming mortgage is one which meets the established rules and procedures of the two major government-sponsored entities in the housing finance market (including some legal requirements). In contrast, lenders who decide to make nonconforming loans are exercising a higher risk tolerance and do so knowing that they face more challenge in reselling the loan. Many countries have similar concepts or agencies that define what are "standard" mortgages. Regulated lenders (such as banks) may be subject to limits or higher risk weightings for non-standard mortgages. For example, banks and mortgage brokerages in Canada face restrictions on lending more than 80% of the property value; beyond this level, mortgage insurance is generally required.
s are common, enabling lenders to lend in a stable foreign currency, whilst the borrower takes on the currency risk
that the currency will depreciate and they will therefore need to convert higher amounts of the domestic currency to repay the loan.
in the U.S. and as a repayment mortgage
in the UK. A mortgage is a form of annuity
(from the perspective of the lender), and the calculation of the periodic payments is based on the time value of money
formulas. Certain details may be specific to different locations: interest may be calculated on the basis of a 360-day year, for example; interest may be compounded
daily, yearly, or semi-annually; prepayment penalties may apply; and other factors. There may be legal restrictions on certain matters, and consumer protection laws may specify or prohibit certain practices.
Depending on the size of the loan and the prevailing practice in the country the term may be short (10 years) or long (50 years plus). In the UK and U.S., 25 to 30 years is the usual maximum term (although shorter periods, such as 15-year mortgage loans, are common). Mortgage payments, which are typically made monthly, contain a capital (repayment of the principal) and an interest element. The amount of capital included in each payment 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 payments are mostly capital and a smaller portion interest. In this way the payment amount determined at outset is calculated to ensure the loan is repaid at a specified date in the future. This gives borrowers assurance that by maintaining repayment the loan will be cleared at a specified date, if the interest rate does not change. Some lenders and 3rd parties offer a Bi-weekly mortgage
payment program designed to accelerate the payoff of the loan.
if an endowment policy is used, similarly a Personal Equity Plan
(PEP) mortgage, Individual Savings Account
(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 dependent on the investment making sufficient return to clear the debt.
Until recently it was not uncommon for interest only mortgages 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 when rent on the property and inflation combine to surpass the interest rate).
These arrangements are variously called reverse mortgage
s, lifetime mortgages or equity release mortgages (referring to home equity
), depending on the country. The loans are typically not repaid until the borrowers die, hence the age restriction. For further details, see equity release
.
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 and interest (repayment) basis.
have increasing costs over time and are geared to young borrowers who expect wage increases over time. Balloon payment mortgage
s have only partial amortization, meaning that 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, and at the end of the term a balloon payment
is due. When interest rates are high relative to the rate on an existing seller's loan, the buyer can consider assuming the seller's mortgage
. A wraparound mortgage
is a form of seller financing
that can make it easier for a seller to sell a property. A biweekly mortgage
has payments made every two weeks instead of monthly.
Budget loans include taxes and insurance in the mortgage payment; package loan
s add the costs of furnishings and other personal property to the mortgage. Buydown mortgages allow the seller or lender to pay something similar to mortgage points to reduce interest rate and encourage buyers. Homeowners can also take out equity loan
s in which they receive cash for a mortgage debt on their house. Shared appreciation mortgage
s are a form of equity release
. In the US, foreign nationals due to their unique situation face Foreign National mortgage
conditions.
Flexible mortgage
s allow for more freedom by the borrower to skip payments or prepay. Offset mortgages allow deposits to be counted against the mortgage loan. in the UK there is also the endowment mortgage
where the borrowers pay interest while the principal is paid with a life insurance policy.
Commercial mortgage
s typically have different interest rates, risks, and contracts than personal loans. Participation mortgage
s allow multiple investors to share in a loan. Builders may take out blanket loan
s which cover several properties at once. Bridge loan
s may be used as temporary financing pending a longer-term loan. Hard money loan
s provide financing in exchange for the mortgaging of real estate collateral.
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.
In virtually all jurisdictions, specific procedures for foreclosure and sale of the mortgaged property apply, and may be tightly regulated by the relevant government. There are strict or judicial foreclosures and non-judicial foreclosures, also known as power of sale foreclosures. 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.
, the Covered bond
s market volume (covered bonds outstanding) amounted to about EUR 2 trillion at year-end 2007 with Germany, Denmark, Spain, and France each having outstandings above 200,000 EUR million. In German language, Pfandbrief
e is the term applied. Pfandbrief-like securities have been introduced in more than 25 European countries – and in recent years also in the U.S. and other countries outside Europe – each with their own unique law and regulations. However, the diffusion of the concept differ: In 2000, the US institutions Fannie Mae and Freddie Mac together reached one per cent of the national population. Furthermore, 87 per cent of their purchased mortgages were granted to borrowers in metropolitan areas with higher income levels. In Europe, a wider market has been achieved: In Denmark, mortgage banks reached 35 per cent of the population in 2002, while the German Bausparkassen achieved widespread regional distribution and more than 30 per cent of the German population concluded a Bauspar contract (as of 2001).
George Soros
's October 10, 2008 Wall Street Journal editorial promoted the Danish mortgage market
model. A survey of European Pfandbrief-like products was issued in 2005 by the Bank for International Settlements
; the International Monetary Fund
in 2007 issued a study of the covered bond
markets in Germany and Spain, while the European Central Bank
in 2003 issued a study of housing markets, addressing also mortgage markets and providing a two page overview of current mortgage systems in the EU countries.
and repossession
.
This policy is typically paid for by the borrower as a component to final nominal (note) rate, or in one lump sum up front, or as a separate and itemized component of monthly mortgage payment. In the last case, mortgage insurance can be dropped when the lender informs the borrower, or its subsequent assigns, that the property has appreciated, the loan has been paid down, or any combination of both to relegate the loan-to-value under 80%.
In the event of repossession, banks, investors, etc. must resort to selling the property to recoup their original investment (the money lent), and are able to dispose of hard assets (such as real estate) more quickly by reductions in price. Therefore, the mortgage insurance acts as a hedge should the repossessing authority recover less than full and fair market value for any hard asset.
ic Sharia
law prohibits the payment or receipt of interest
, meaning that 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.
Typically, this may lead to a higher final price for the buyers. This is because in some countries (such as the United Kingdom and India) there is a Stamp Duty
which is a tax charged by the government on a change of ownership. Because ownership changes twice in an Islamic mortgage, a stamp tax may be charged twice. Many other jurisdictions have similar transaction taxes on change of ownership which may be levied. In the United Kingdom, the dual application of Stamp Duty
in such transactions was removed in the Finance Act 2003 in order to facilitate Islamic mortgages.
An alternative scheme involves the bank reselling the property according to an installment plan, at a price higher than the original price.
Both of these methods compensate the lender as if they were charging interest, but the loans are structured in a way that in name they are not, and the lender shares the financial risks involved in the transaction with the homebuyer.
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
secured
Collateral (finance)
In lending agreements, collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan.The collateral serves as protection for a lender against a borrower's default - that is, any borrower failing to pay the principal and interest under the terms of a loan obligation...
by real property
Real property
In English Common Law, real property, real estate, realty, or immovable property is any subset of land that has been legally defined and the improvements to it made by human efforts: any buildings, machinery, wells, dams, ponds, mines, canals, roads, various property rights, and so forth...
through the use of a mortgage note
Mortgage note
In the US a mortgage note is a promissory note associated with a specified mortgage loan; it is a written promise to repay a specified sum of money plus interest at a specified rate and length of time to fulfill the promise...
which evidences the existence of the loan and the encumbrance
Encumbrance
Encumbrance is legal technical terminology for anything that affects or limits the title of a property, such as mortgages, leases, easements, liens, or restrictions. Also, those considered as potentially making the title defeasible are encumbrances...
of that realty through the granting of a mortgage which secures
Security interest
A security interest is a property interest created by agreement or by operation of law over assets to secure the performance of an obligation, usually the payment of a debt. It gives the beneficiary of the security interest certain preferential rights in the disposition of secured assets...
the loan. However, the word mortgage alone, in everyday usage, is most often used to mean mortgage loan.
A home buyer or builder can obtain financing (a loan) either to purchase or secure against the property from a financial institution, such as a bank
Bank
A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...
, either directly or indirectly through intermediaries. Features of mortgage loans such as the size of the loan, maturity of the loan, interest rate, method of paying off the loan, and other characteristics can vary considerably.
In many jurisdictions, though not all (Bali, Indonesia
Bali
Bali is an Indonesian island located in the westernmost end of the Lesser Sunda Islands, lying between Java to the west and Lombok to the east...
being one exception), it is normal for home purchases to be funded by a mortgage loan. Few individuals have enough savings or liquid funds to enable them to purchase property outright. In countries where the demand for home ownership is highest, strong domestic markets have developed.
The word mortgage is a Law French
Law French
Law French is an archaic language originally based on Old Norman and Anglo-Norman, but increasingly influenced by Parisian French and, later, English. It was used in the law courts of England, beginning with the Norman Conquest by William the Conqueror...
term meaning "dead pledge," apparently meaning that the pledge ends (dies) either when the obligation is fulfilled or the property is taken through foreclosure
Foreclosure
Foreclosure is the legal process by which a mortgage lender , or other lien holder, obtains a termination of a mortgage borrower 's equitable right of redemption, either by court order or by operation of law...
.
Basic concepts and legal regulation
According to Anglo-American property lawProperty law
Property law is the area of law that governs the various forms of ownership in real property and in personal property, within the common law legal system. In the civil law system, there is a division between movable and immovable property...
, a mortgage occurs when an owner (usually of a fee simple
Fee simple
In English law, a fee simple is an estate in land, a form of freehold ownership. It is the most common way that real estate is owned in common law countries, and is ordinarily the most complete ownership interest that can be had in real property short of allodial title, which is often reserved...
interest in realty
Real property
In English Common Law, real property, real estate, realty, or immovable property is any subset of land that has been legally defined and the improvements to it made by human efforts: any buildings, machinery, wells, dams, ponds, mines, canals, roads, various property rights, and so forth...
) pledges his or her interest (right to the property) as security
Security (finance)
A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...
or collateral
Collateral (finance)
In lending agreements, collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan.The collateral serves as protection for a lender against a borrower's default - that is, any borrower failing to pay the principal and interest under the terms of a loan obligation...
for a loan. Therefore, a mortgage is an encumbrance
Encumbrance
Encumbrance is legal technical terminology for anything that affects or limits the title of a property, such as mortgages, leases, easements, liens, or restrictions. Also, those considered as potentially making the title defeasible are encumbrances...
(limitation) on the right to the property just as an easement
Easement
An easement is a certain right to use the real property of another without possessing it.Easements are helpful for providing pathways across two or more pieces of property or allowing an individual to fish in a privately owned pond...
would be, but because most mortgages occur as a condition for new loan money, the word mortgage has become the generic term for a loan
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
secured by such real property
Real property
In English Common Law, real property, real estate, realty, or immovable property is any subset of land that has been legally defined and the improvements to it made by human efforts: any buildings, machinery, wells, dams, ponds, mines, canals, roads, various property rights, and so forth...
.
As with other types of loans, mortgages have an interest rate and are scheduled to amortize over a set period of time, typically 30 years. All types of real property can be, and usually are, secured with a mortgage and bear an interest rate that is supposed to reflect the lender's risk.
Mortgage lending is the primary mechanism used in many countries to finance private ownership of residential and commercial property (see commercial mortgage
Commercial mortgage
A commercial mortgage is a mortgage loan made using commercial real estate as collateral to secure repayment.A commercial mortgage is similar to a residential mortgage, except the collateral is a commercial building or other business real estate, not residential property. In addition, commercial...
s). Although the terminology and precise forms will differ from country to country, the basic components tend to be similar:
- Property: the physical residence being financed. The exact form of ownership will vary from country to country, and may restrict the types of lending that are possible.
- Mortgage: the security interestSecurity interestA security interest is a property interest created by agreement or by operation of law over assets to secure the performance of an obligation, usually the payment of a debt. It gives the beneficiary of the security interest certain preferential rights in the disposition of secured assets...
of the lender in the property, which may entail restrictions on the use or disposal of the property. Restrictions may include requirements to purchase home insuranceHome insuranceHome insurance, also commonly called hazard insurance or homeowner's insurance , is the type of property insurance that covers private homes...
and mortgage insuranceMortgage insuranceMortgage insurance is an insurance policy which compensates lenders or investors for losses due to the default of a mortgage loan. Mortgage insurance can be either public or private depending upon the insurer...
, or pay off outstanding debt before selling the property. - Borrower: the person borrowing who either has or is creating an ownership interest in the property.
- Lender: any lender, but usually a bankBankA bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...
or other financial institutionFinancial institutionIn financial economics, a financial institution is an institution that provides financial services for its clients or members. Probably the most important financial service provided by financial institutions is acting as financial intermediaries...
. Lenders may also be investorInvestorAn investor is a party that makes an investment into one or more categories of assets --- equity, debt securities, real estate, currency, commodity, derivatives such as put and call options, etc...
s who own an interest in the mortgage through a mortgage-backed securityMortgage-backed securityA mortgage-backed security is an asset-backed security that represents a claim on the cash flows from mortgage loans through a process known as securitization.-Securitization:...
. In such a situation, the initial lender is known as the mortgage originator, which then packages and sells the loan to investors. The payments from the borrower are thereafter collected by a loan servicerLoan servicerA loan servicer is a public or private entity that collects, monitors and reports loan payments, handles property tax, insurance escrows and late payments, forecloses defaulted loans, and remits payments....
. - Principal: the original size of the loan, which may or may not include certain other costs; as any principal is repaid, the principal will go down in size.
- InterestInterestInterest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....
: a financial charge for use of the lender's money. - ForeclosureForeclosureForeclosure is the legal process by which a mortgage lender , or other lien holder, obtains a termination of a mortgage borrower 's equitable right of redemption, either by court order or by operation of law...
or repossessionRepossessionRepossession is generally used to refer to a financial institution taking back an object that was either used as collateral or rented or leased in a transaction. Repossession is a "self-help" type of action in which the party having right of ownership of the property in question takes the property...
: the possibility that the lender has to foreclose, repossess or seize the property under certain circumstances is essential to a mortgage loan; without this aspect, the loan is arguably no different from any other type of loan.
Many other specific characteristics are common to many markets, but the above are the essential features. Governments usually regulate many aspects of mortgage lending, either directly (through legal requirements, for example) or indirectly (through regulation of the participants or the financial markets, such as the banking industry), and often through state intervention (direct lending by the government, by state-owned banks, or sponsorship of various entities). Other aspects that define a specific mortgage market may be regional, historical, or driven by specific characteristics of the legal or financial system.
Mortgage loans are generally structured as long-term loans, the periodic payments for which are similar to an annuity
Annuity (finance theory)
The term annuity is used in finance theory to refer to any terminating stream of fixed payments over a specified period of time. This usage is most commonly seen in discussions of finance, usually in connection with the valuation of the stream of payments, taking into account time value of money...
and calculated according to the time value of money
Time value of money
The time value of money is the value of money figuring in a given amount of interest earned over a given amount of time. The time value of money is the central concept in finance theory....
formulae. The most basic arrangement would require a fixed monthly payment over a period of ten to thirty years, depending on local conditions. Over this period the principal component of the loan (the original loan) would be slowly paid down through amortization
Amortization
Amortization is the process of decreasing, or accounting for, an amount over a period. The word comes from Middle English amortisen to kill, alienate in mortmain, from Anglo-French amorteser, alteration of amortir, from Vulgar Latin admortire to kill, from Latin ad- + mort-, mors death.When used...
. In practice, many variants are possible and common worldwide and within each country.
Lenders provide funds against property to earn interest income, and generally borrow these funds themselves (for example, by taking deposits or issuing bonds
Bond (finance)
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...
). The price at which the lenders borrow money therefore affects the cost of borrowing. Lenders may also, in many countries, sell the mortgage loan to other parties who are interested in receiving the stream of cash payments from the borrower, often in the form of a security (by means of a securitization
Securitization
Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling said consolidated debt as bonds, pass-through securities, or Collateralized mortgage obligation , to...
).
Mortgage lending will also take into account the (perceived) riskiness of the mortgage loan, that is, the likelihood that the funds will be repaid (usually considered a function of the creditworthiness of the borrower); that if they are not repaid, the lender will be able to foreclose and recoup some or all of its original capital; and the financial, interest rate risk
Interest rate risk
Interest rate risk is the risk borne by an interest-bearing asset, such as a loan or a bond, due to variability of interest rates. In general, as rates rise, the price of a fixed rate bond will fall, and vice versa...
and time delays that may be involved in certain circumstances.
Mortgage loan types
There are many types of mortgages used worldwide, but several factors broadly define the characteristics of the mortgage. All of these may be subject to local regulation and legal requirements.- Interest: interest may be fixed for the life of the loan or variable, and change at certain pre-defined periods; the interest rate can also, of course, be higher or lower.
- Term: mortgage loans generally have a maximum term, that is, the number of years after which an amortizing loan will be repaid. Some mortgage loans may have no amortization, or require full repayment of any remaining balance at a certain date, or even negative amortizationNegative amortizationIn finance, negative amortization, also known as NegAm, deferred interest or graduated payment mortgage, occurs whenever the loan payment for any period is less than the interest charged over that period so that the outstanding balance of the loan increases...
. - Payment amount and frequency: the amount paid per period and the frequency of payments; in some cases, the amount paid per period may change or the borrower may have the option to increase or decrease the amount paid.
- Prepayment: some types of mortgages may limit or restrict prepayment of all or a portion of the loan, or require payment of a penalty to the lender for prepayment.
The two basic types of amortized loans are the fixed rate mortgage
Fixed rate mortgage
A fixed-rate mortgage is a mortgage loan first developed by the Federal Housing Administration where the interest rate on the note remains the same through the term of the loan, as opposed to loans where the interest rate may adjust or "float." Other forms of mortgage loan include interest only...
(FRM) and adjustable-rate mortgage (ARM) (also known as a floating rate
Floating interest rate
A floating interest rate, also known as a variable rate or adjustable rate, refers to any type of debt instrument, such as a loan, bond, mortgage, or credit, that does not have a fixed rate of interest over the life of the instrument....
or variable rate mortgage). In many countries (such as the United States), floating rate mortgages are the norm and will simply be referred to as mortgages. Combinations of fixed and floating rate are also common, whereby a mortgage loan will have a fixed rate for some period, and vary after the end of that period.
- In a fixed rate mortgage, the interest rate, and hence periodic payment, remains fixed for the life (or term) of the loan. Therefore the payment is fixed, although ancillary costs (such as property taxes and insurance) can and do change. For a fixed rate mortgage, payments for principal and interest should not change over the life of the loan,
- In an adjustable rate mortgage, the interest rate is generally fixed for a period of time, after which it will periodically (for example, annually or monthly) adjust up or down to some market index. Adjustable rates transfer part of the interest rate risk from the lender to the borrower, and thus are widely used where fixed rate funding is difficult to obtain or prohibitively expensive. Since the risk is transferred to the borrower, the initial interest rate may be from 0.5% to 2% lower than the average 30-year fixed rate; the size of the price differential will be related to debt market conditions, including the yield curveYield curveIn finance, the yield curve is the relation between the interest rate and the time to maturity, known as the "term", of the debt for a given borrower in a given currency. For example, the U.S. dollar interest rates paid on U.S...
.
The charge to the borrower depends upon the credit risk in addition to the interest rate risk. The mortgage origination and underwriting process involves checking credit scores, debt-to-income, downpayments, and assets. Jumbo mortgages and subprime lending
Subprime lending
In finance, subprime lending means making loans to people who may have difficulty maintaining the repayment schedule...
are not supported by government guarantees and face higher interest rates. Other innovations described below can affect the rates as well.
Loan to value and downpayments
Upon making a mortgage loan for the purchase of a property, lenders usually require that the borrower make a downpayment; that is, contribute a portion of the cost of the property. This downpayment may be expressed as a portion of the value of the property (see below for a definition of this term). The loan to value ratio (or LTV) is the size of the loan against the value of the property. Therefore, a mortgage loan in which the purchaser has made a downpayment of 20% has a loan to value ratio of 80%. For loans made against properties that the borrower already owns, the loan to value ratio will be imputed against the estimated value of the property.The loan to value ratio is considered an important indicator of the riskiness of a mortgage loan: the higher the LTV, the higher the risk that the value of the property (in case of foreclosure) will be insufficient to cover the remaining principal of the loan.
Value: appraised, estimated, and actual
Since the value of the property is an important factor in understanding the risk of the loan, determining the value is a key factor in mortgage lending. The value may be determined in various ways, but the most common are:- Actual or transaction value: this is usually taken to be the purchase price of the property. If the property is not being purchased at the time of borrowing, this information may not be available.
- Appraised or surveyed value: in most jurisdictions, some form of appraisal of the value by a licensed professional is common. There is often a requirement for the lender to obtain an official appraisal.
- Estimated value: lenders or other parties may use their own internal estimates, particularly in jurisdictions where no official appraisal procedure exists, but also in some other circumstances.
Payment and debt ratios
In most countries, a number of more or less standard measures of creditworthiness may be used. Common measures include payment to income (mortgage payments as a percentage of gross or net income); debt to incomeDebt-to-income ratio
A debt-to-income ratio is the percentage of a consumer's monthly gross income that goes toward paying debts. A debt-to-income ratio (often abbreviated DTI) is the percentage of a consumer's monthly gross income that goes toward paying debts. A debt-to-income ratio (often abbreviated DTI) is the...
(all debt payments, including mortgage payments, as a percentage of income); and various net worth measures. In many countries, credit score
Credit score
A credit score is a numerical expression based on a statistical analysis of a person's credit files, to represent the creditworthiness of that person...
s are used in lieu of or to supplement these measures. There will also be requirements for documentation of the creditworthiness, such as income tax returns, pay stubs, etc; the specifics will vary from location to location.
Some lenders may also require a potential borrower have one or more months of "reserve assets" available. In other words, the borrower may be required to show the availability of enough assets to pay for the housing costs (including mortgage, taxes, etc.) for a period of time in the event of the job loss or other loss of income.
Many countries have lower requirements for certain borrowers, or "no-doc" / "low-doc" lending standards that may be acceptable in certain circumstances.
Standard or conforming mortgages
Many countries have a notion of standard or conforming mortgages that define a perceived acceptable level of risk, which may be formal or informal, and may be reinforced by laws, government intervention, or market practice. For example, a standard mortgage may be considered to be one with no more than 70-80% LTV and no more than one-third of gross income going to mortgage debt.A standard or conforming mortgage is a key concept as it often defines whether or not the mortgage can be easily sold or securitized, or, if non-standard, may affect the price at which it may be sold. In the United States, a conforming mortgage is one which meets the established rules and procedures of the two major government-sponsored entities in the housing finance market (including some legal requirements). In contrast, lenders who decide to make nonconforming loans are exercising a higher risk tolerance and do so knowing that they face more challenge in reselling the loan. Many countries have similar concepts or agencies that define what are "standard" mortgages. Regulated lenders (such as banks) may be subject to limits or higher risk weightings for non-standard mortgages. For example, banks and mortgage brokerages in Canada face restrictions on lending more than 80% of the property value; beyond this level, mortgage insurance is generally required.
Foreign currency mortgage
In some countries with currencies that tend to depreciate, foreign currency mortgageForeign currency mortgage
A foreign currency mortgage is a mortgage which is repayable in a currency other than the currency of the country in which the borrower is a resident...
s are common, enabling lenders to lend in a stable foreign currency, whilst the borrower takes on the currency risk
Currency risk
Currency risk or exchange rate risk is a form of financial risk that arises from the potential change in the exchange rate of one currency in relation to another...
that the currency will depreciate and they will therefore need to convert higher amounts of the domestic currency to repay the loan.
Repaying the mortgage
In addition to the two standard means of setting the cost of a mortgage loan (fixed at a set interest rate for the term, or variable relative to market interest rates), there are variations in how that cost is paid, and how the loan itself is repaid. Repayment depends on locality, tax laws and prevailing culture. There are also various mortgage repayment structures to suit different types of borrower.Capital and interest
The most common way to repay a secured mortgage loan is to make regular payments of the capital (also called the principal) and interest over a set term. This is commonly referred to as (self) amortizationAmortization (business)
In business, amortization refers to spreading payments over multiple periods. The term is used for two separate processes: amortization of loans and amortization of intangible assets.-Amortization of loans:...
in the U.S. and as a repayment mortgage
Repayment mortgage
A repayment mortgage is a term generally used in the UK to describe a mortgage in which the monthly repayments consist of repaying the capital amount borrowed as well as the accrued interest, so that the amount borrowed decreases throughout the term and by the end of the loan term has been fully...
in the UK. A mortgage is a form of annuity
Annuity (finance theory)
The term annuity is used in finance theory to refer to any terminating stream of fixed payments over a specified period of time. This usage is most commonly seen in discussions of finance, usually in connection with the valuation of the stream of payments, taking into account time value of money...
(from the perspective of the lender), and the calculation of the periodic payments is based on the time value of money
Time value of money
The time value of money is the value of money figuring in a given amount of interest earned over a given amount of time. The time value of money is the central concept in finance theory....
formulas. Certain details may be specific to different locations: interest may be calculated on the basis of a 360-day year, for example; interest may be compounded
Compound interest
Compound interest arises when interest is added to the principal, so that from that moment on, the interest that has been added also itself earns interest. This addition of interest to the principal is called compounding...
daily, yearly, or semi-annually; prepayment penalties may apply; and other factors. There may be legal restrictions on certain matters, and consumer protection laws may specify or prohibit certain practices.
Depending on the size of the loan and the prevailing practice in the country the term may be short (10 years) or long (50 years plus). In the UK and U.S., 25 to 30 years is the usual maximum term (although shorter periods, such as 15-year mortgage loans, are common). Mortgage payments, which are typically made monthly, contain a capital (repayment of the principal) and an interest element. The amount of capital included in each payment 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 payments are mostly capital and a smaller portion interest. In this way the payment amount determined at outset is calculated to ensure the loan is repaid at a specified date in the future. This gives borrowers assurance that by maintaining repayment the loan will be cleared at a specified date, if the interest rate does not change. Some lenders and 3rd parties offer a Bi-weekly mortgage
Biweekly Mortgage
A Biweekly mortgage is a mortgage loan payment plan where the borrower makes payments toward his/her principal and interest every two weeks instead of once monthly. The Biweekly payment is exactly one half of the amount a monthly payment would be...
payment program designed to accelerate the payoff of the loan.
Interest only
The main alternative to a 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 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 mortgageEndowment mortgage
An endowment mortgage is a mortgage loan arranged on an interest-only basis where the capital is intended to be repaid by one or more endowment policies. The phrase endowment mortgage is used mainly in the United Kingdom by lenders and consumers to refer to this arrangement and is not a legal...
if an endowment policy is used, similarly a Personal Equity Plan
Personal Equity Plan
In the United Kingdom a Personal Equity Plan was a form of tax-privileged investment account. They were introduced by Nigel Lawson in the 1986 budget for Margaret Thatcher's Conservative government to encourage equity ownership among the wider population. PEPs were allowed to contain collective...
(PEP) mortgage, Individual Savings Account
Individual Savings Account
An Individual Savings Account is a financial product available to residents in the United Kingdom. It is designed for the purpose of investment and savings with a favourable tax status. Money is contributed from after tax income and not subjected to income tax or capital gains tax within a holding...
(ISA) mortgage or pension mortgage
Pension fund
A pension fund is any plan, fund, or scheme which provides retirement income.Pension funds are important shareholders of listed and private companies. They are especially important to the stock market where large institutional investors dominate. The largest 300 pension funds collectively hold...
. 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 dependent on the investment making sufficient return to clear the debt.
Until recently it was not uncommon for interest only mortgages 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 when rent on the property and inflation combine to surpass the interest rate).
No capital or interest
For older borrowers (typically in retirement), it may be 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 mortgage
Reverse mortgage
A remortgage is a form of equity release available in the United States. It is a loan available to seniors aged 62 or older, under a Federal program administered by HUD. It enables eligible homeowners to access a portion of their equity...
s, lifetime mortgages or equity release mortgages (referring to home equity
Home equity
Home equity is the market value of a homeowner's unencumbered interest in their real property—that is, the difference between the home's fair market value and the outstanding balance of all liens on the property. The property's equity increases as the debtor makes payments against the...
), depending on the country. The loans are typically not repaid until the borrowers die, hence the age restriction. For further details, see equity release
Equity release
Equity release is a means of retaining use of your house or other object which has capital value, while also obtaining a lump sum or a steady stream of income, using the value of the house....
.
Interest and partial capital
In the U.S. a partial amortization or balloon loanBullet loan
In banking and finance, a bullet loan is a loan where a payment of the entire principal of the loan, and sometimes the principal and interest, is due at the end of the loan term. Likewise for bullet bond...
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 and interest (repayment) basis.
Variations
Graduated payment mortgage loanGraduated payment mortgage loan
A graduated payment mortgage loan, often referred to as GPM, is a mortgage with low initial monthly payments which gradually increase over a specified time frame. These plans are mostly geared towards young men and women who cannot afford large payments now, but can realistically expect to do...
have increasing costs over time and are geared to young borrowers who expect wage increases over time. Balloon payment mortgage
Balloon payment mortgage
A balloon payment mortgage is a mortgage which does not fully amortize over the term of the note, thus leaving a balance due at maturity. The final payment is called a balloon payment because of its large size. Balloon payment mortgages are more common in commercial real estate than in...
s have only partial amortization, meaning that 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, and at the end of the term a balloon payment
Balloon payment
When a debt is repaid in payments of varying amounts there are some colourful jargon terms used to describe the different loan structures. The term balloon payment arises because if you hold back most of a debt and pay it only towards the end of the agreement, both those last payments and the total...
is due. When interest rates are high relative to the rate on an existing seller's loan, the buyer can consider assuming the seller's mortgage
Assumed mortgage
In real estate an assumed mortgage occurs when a the buyer of a real property is transferred all the obligations of the seller's mortgage.The buyer assumes all the obligations under the mortgage, just as if the loan had been made to the buyer. The major driving force behind assumptions is the...
. A wraparound mortgage
Wraparound mortgage
A wrap-around mortgage, more-commonly known as a "wrap", is a form of secondary financing for the purchase of real property. The seller extends to the buyer a junior mortgage which wraps around and exists in addition to any superior mortgages already secured by the property...
is a form of seller financing
Seller financing
Seller financing is a loan provided by the seller of a property or business to the purchaser. Usually, the purchaser will make some sort of down payment to the seller, and then make installment payments over a specified time, at an agreed-upon interest rate, until the loan is fully repaid...
that can make it easier for a seller to sell a property. A biweekly mortgage
Biweekly Mortgage
A Biweekly mortgage is a mortgage loan payment plan where the borrower makes payments toward his/her principal and interest every two weeks instead of once monthly. The Biweekly payment is exactly one half of the amount a monthly payment would be...
has payments made every two weeks instead of monthly.
Budget loans include taxes and insurance in the mortgage payment; package loan
Package loan
A package loan is a real estate loan used to finance the purchase of both real property and personal property, such as in the purchase of a new home that includes carpeting, window coverings and major appliances....
s add the costs of furnishings and other personal property to the mortgage. Buydown mortgages allow the seller or lender to pay something similar to mortgage points to reduce interest rate and encourage buyers. Homeowners can also take out equity loan
Equity loan
An equity loan is a mortgage loan in which the borrower receives cash. Typically the loan is secured by real estate already owned outright.For example, if a person owns a home worth $100,000, but does not currently have a mortgage on it, they may take an equity loan at 80% loan to value or $80,000...
s in which they receive cash for a mortgage debt on their house. Shared appreciation mortgage
Shared appreciation mortgage
A shared appreciation mortgage or SAM is a mortgage in which the lender agrees as part of the loan to accept some or all payment in the form of a share of the increase in value of the property.- In the UK :...
s are a form of equity release
Equity release
Equity release is a means of retaining use of your house or other object which has capital value, while also obtaining a lump sum or a steady stream of income, using the value of the house....
. In the US, foreign nationals due to their unique situation face Foreign National mortgage
Foreign National mortgage
A mortgage to a non resident is called a Foreign National Mortgage loan. A foreign national who is not a resident of the United States will in many cases seek to own real estate. Financing real estate is generally done by US mortgage companies and banks to United States citizens.Lenders also offer...
conditions.
Flexible mortgage
Flexible mortgage
The term flexible mortgage refers to a residential mortgage loan that offers flexibility in the requirements to make monthly repayments. The flexible mortgage first appeared in Australia in the early 1990s , however it did not gain popularity until the late 1990s...
s allow for more freedom by the borrower to skip payments or prepay. Offset mortgages allow deposits to be counted against the mortgage loan. in the UK there is also the endowment mortgage
Endowment mortgage
An endowment mortgage is a mortgage loan arranged on an interest-only basis where the capital is intended to be repaid by one or more endowment policies. The phrase endowment mortgage is used mainly in the United Kingdom by lenders and consumers to refer to this arrangement and is not a legal...
where the borrowers pay interest while the principal is paid with a life insurance policy.
Commercial mortgage
Commercial mortgage
A commercial mortgage is a mortgage loan made using commercial real estate as collateral to secure repayment.A commercial mortgage is similar to a residential mortgage, except the collateral is a commercial building or other business real estate, not residential property. In addition, commercial...
s typically have different interest rates, risks, and contracts than personal loans. Participation mortgage
Participation mortgage
A participation mortgage or participating mortgage is a mortgage loan, or sometimes a group of them, in which two or more persons have fractional equitable interests. In this arrangement the lender, or mortgagee, is entitled to share in the rental or resale proceeds from a property owned by the...
s allow multiple investors to share in a loan. Builders may take out blanket loan
Blanket loan
A blanket loan, or blanket mortgage, is a type of loan used to fund the purchase of more than one piece of real property. Blanket loans are popular with builders and developers who buy large tracts of land, then subdivide them to create many individual parcels to be gradually sold one at a time...
s which cover several properties at once. Bridge loan
Bridge loan
A bridge loan is a type of short-term loan, typically taken out for a period of 2 weeks to 3 years pending the arrangement of larger or longer-term financing.-Description:A bridge loan is interim financing for an individual or business until...
s may be used as temporary financing pending a longer-term loan. Hard money loan
Hard money loan
A hard money loan is a specific type of asset-based loan financing through which a borrower receives funds secured by the value of a parcel of real estate. Hard money loans are typically issued by private investors or companies...
s provide financing in exchange for the mortgaging of real estate collateral.
Foreclosure and non-recourse lending
In most jurisdictions, a lender may foreclose the mortgaged property if certain conditions - principally, non-payment of the mortgage loan - occur. 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-recourseSecured loan
A secured loan is a loan in which the borrower pledges some asset as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan...
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.
In virtually all jurisdictions, specific procedures for foreclosure and sale of the mortgaged property apply, and may be tightly regulated by the relevant government. There are strict or judicial foreclosures and non-judicial foreclosures, also known as power of sale foreclosures. 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.
Mortgage lending: United States
Mortgage lending in Continental Europe
Within the European UnionEuropean Union
The European Union is an economic and political union of 27 independent member states which are located primarily in Europe. The EU traces its origins from the European Coal and Steel Community and the European Economic Community , formed by six countries in 1958...
, the Covered bond
Covered bond
Covered bonds are debt securities backed by cash flows from mortgages or public sector loans. They are similar in many ways to asset-backed securities created in securitization, but covered bond assets remain on the issuer’s consolidated balance sheet....
s market volume (covered bonds outstanding) amounted to about EUR 2 trillion at year-end 2007 with Germany, Denmark, Spain, and France each having outstandings above 200,000 EUR million. In German language, Pfandbrief
Pfandbrief
The Pfandbrief , a mostly triple-A rated German bank debenture, has become the blueprint of many covered bond models in Europe and beyond. The Pfandbrief is collateralized by long-term assets such as property mortgages or public sector loans as stipulated in the Pfandbrief Act. Total volume...
e is the term applied. Pfandbrief-like securities have been introduced in more than 25 European countries – and in recent years also in the U.S. and other countries outside Europe – each with their own unique law and regulations. However, the diffusion of the concept differ: In 2000, the US institutions Fannie Mae and Freddie Mac together reached one per cent of the national population. Furthermore, 87 per cent of their purchased mortgages were granted to borrowers in metropolitan areas with higher income levels. In Europe, a wider market has been achieved: In Denmark, mortgage banks reached 35 per cent of the population in 2002, while the German Bausparkassen achieved widespread regional distribution and more than 30 per cent of the German population concluded a Bauspar contract (as of 2001).
Costs
A study issued by the UN Economic Commission for Europe compared German, US, and Danish mortgage systems. The German Bausparkassen have reported nominal interest rates of approximately 6 per cent per annum in the last 40 years (as of 2004). In addition, they charge administration and service fees (about 1.5 per cent of the loan amount). In the United States, the average interest rates for fixed-rate mortgages in the housing market started in the tens and twenties in the 1980s and have (as of 2004) reached about 6 per cent per annum. However, gross borrowing costs are substantially higher than the nominal interest rate and amounted for the last 30 years to 10.46 per cent. In Denmark, similar to the United States capital market, interest rates have fallen to 6 per cent per annum. A risk and administration fee amounts to 0.5 per cent of the outstanding debt. In addition, an acquisition fee is charged which amounts to one per cent of the principal.Recent trends
On July 28, 2008, US Treasury Secretary Henry Paulson announced that, along with four large U.S. banks, the Treasury would attempt to kick start a market for these securities in the United States, primarily to provide an alternative form of mortgage-backed securities. Similarly, in the UK "the Government is inviting views on options for a UK framework to deliver more affordable long-term fixed-rate mortgages, including the lessons to be learned from international markets and institutions".George Soros
George Soros
George Soros is a Hungarian-American business magnate, investor, philosopher, and philanthropist. He is the chairman of Soros Fund Management. Soros supports progressive-liberal causes...
's October 10, 2008 Wall Street Journal editorial promoted the Danish mortgage market
Danish mortgage market
The mortgage industry of Denmark has proved very effective in providing borrowers with flexible and transparent loans on conditions close to the funding conditions of capital market players. Simultaneously, the covered mortgage bonds transfer market risk from the issuing mortgage bank to bond...
model. A survey of European Pfandbrief-like products was issued in 2005 by the Bank for International Settlements
Bank for International Settlements
The Bank for International Settlements is an intergovernmental organization of central banks which "fosters international monetary and financial cooperation and serves as a bank for central banks." It is not accountable to any national government...
; the International Monetary Fund
International Monetary Fund
The International Monetary Fund is an organization of 187 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world...
in 2007 issued a study of the covered bond
Covered bond
Covered bonds are debt securities backed by cash flows from mortgages or public sector loans. They are similar in many ways to asset-backed securities created in securitization, but covered bond assets remain on the issuer’s consolidated balance sheet....
markets in Germany and Spain, while the European Central Bank
European Central Bank
The European Central Bank is the institution of the European Union that administers the monetary policy of the 17 EU Eurozone member states. It is thus one of the world's most important central banks. The bank was established by the Treaty of Amsterdam in 1998, and is headquartered in Frankfurt,...
in 2003 issued a study of housing markets, addressing also mortgage markets and providing a two page overview of current mortgage systems in the EU countries.
History
While the idea originated in Prussia in 1769, a Danish act on mortgage credit associations of 1850 enabled the issuing of bonds (Danish: Realkreditobligationer) as a means to refinance mortgage loans. With the German mortgage banks law of 1900, the whole German Empire was given a standardized legal foundation for the emission of Pfandbriefe. An account from the perspective of development economics is available.Mortgage insurance
Mortgage insurance is an insurance policy designed to protect the mortgagee (lender) from any default by the mortgagor (borrower). It is used commonly in loans with a loan-to-value ratio over 80%, and employed in the event of foreclosureForeclosure
Foreclosure is the legal process by which a mortgage lender , or other lien holder, obtains a termination of a mortgage borrower 's equitable right of redemption, either by court order or by operation of law...
and repossession
Repossession
Repossession is generally used to refer to a financial institution taking back an object that was either used as collateral or rented or leased in a transaction. Repossession is a "self-help" type of action in which the party having right of ownership of the property in question takes the property...
.
This policy is typically paid for by the borrower as a component to final nominal (note) rate, or in one lump sum up front, or as a separate and itemized component of monthly mortgage payment. In the last case, mortgage insurance can be dropped when the lender informs the borrower, or its subsequent assigns, that the property has appreciated, the loan has been paid down, or any combination of both to relegate the loan-to-value under 80%.
In the event of repossession, banks, investors, etc. must resort to selling the property to recoup their original investment (the money lent), and are able to dispose of hard assets (such as real estate) more quickly by reductions in price. Therefore, the mortgage insurance acts as a hedge should the repossessing authority recover less than full and fair market value for any hard asset.
Islamic mortgages
IslamIslam
Islam . The most common are and . : Arabic pronunciation varies regionally. The first vowel ranges from ~~. The second vowel ranges from ~~~...
ic Sharia
Sharia
Sharia law, is the moral code and religious law of Islam. Sharia is derived from two primary sources of Islamic law: the precepts set forth in the Quran, and the example set by the Islamic prophet Muhammad in the Sunnah. Fiqh jurisprudence interprets and extends the application of sharia to...
law prohibits the payment or receipt of interest
Interest
Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....
, meaning that 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
Economic rent
Economic rent is typically defined by economists as payment for goods and services beyond the amount needed to bring the required factors of production into a production process and sustain supply. A recipient of economic rent is a rentier....
, will pay a contribution towards the purchase of the property. When the last payment is made, the property changes hands.
Typically, this may lead to a higher final price for the buyers. This is because in some countries (such as the United Kingdom and India) there is a Stamp Duty
Stamp duty
Stamp duty is a tax that is levied on documents. Historically, this included the majority of legal documents such as cheques, receipts, military commissions, marriage licences and land transactions. A physical stamp had to be attached to or impressed upon the document to denote that stamp duty...
which is a tax charged by the government on a change of ownership. Because ownership changes twice in an Islamic mortgage, a stamp tax may be charged twice. Many other jurisdictions have similar transaction taxes on change of ownership which may be levied. In the United Kingdom, the dual application of Stamp Duty
Stamp duty
Stamp duty is a tax that is levied on documents. Historically, this included the majority of legal documents such as cheques, receipts, military commissions, marriage licences and land transactions. A physical stamp had to be attached to or impressed upon the document to denote that stamp duty...
in such transactions was removed in the Finance Act 2003 in order to facilitate Islamic mortgages.
An alternative scheme involves the bank reselling the property according to an installment plan, at a price higher than the original price.
Both of these methods compensate the lender as if they were charging interest, but the loans are structured in a way that in name they are not, and the lender shares the financial risks involved in the transaction with the homebuyer.
General, or related to more than one nation
- Commercial mortgageCommercial mortgageA commercial mortgage is a mortgage loan made using commercial real estate as collateral to secure repayment.A commercial mortgage is similar to a residential mortgage, except the collateral is a commercial building or other business real estate, not residential property. In addition, commercial...
- Nonrecourse debtNonrecourse debtNon-recourse debt or a non-recourse loan is a secured loan that is secured by a pledge of collateral, typically real property, but for which the borrower is not personally liable. If the borrower defaults, the lender/issuer can seize the collateral, but the lender's recovery is limited to the...
- RefinancingRefinancingRefinancing may refer to the replacement of an existing debt obligation with a debt obligation under different terms. The terms and conditions of refinancing may vary widely by country, province, or state, based on several economic factors such as, inherent risk, projected risk, political...
- No Income No AssetNo Income No AssetNo Income No Asset , No Income No Job or Asset or simply Nina Loan is a term used in the United States mortgage industry to describe one of many documentation types which lenders may allow when underwriting a mortgage....
(NINA) - Annual percentage rateAnnual percentage rateThe term annual percentage rate , also called nominal APR, and the term effective APR, also called EAR, describe the interest rate for a whole year , rather than just a monthly fee/rate, as applied on a loan, mortgage loan, credit card, etc. It is a finance charge expressed as an annual rate...
Related to the United States
- Commercial lender (US)Commercial lender (US)In the United States a commercial lender offers loans backed by hard collateral. In most cases this is real estate, but it can also include factoring, non-conforming assets, or other sources of collateral.-Commercial lending practices:...
- a term for a lender collateralizing non-residential properties. - Fixed rate mortgageFixed rate mortgageA fixed-rate mortgage is a mortgage loan first developed by the Federal Housing Administration where the interest rate on the note remains the same through the term of the loan, as opposed to loans where the interest rate may adjust or "float." Other forms of mortgage loan include interest only...
calculations (USA) - pre-qualificationPre-qualificationPre-qualification is a term of art in retail finance, and means that a loan officer has taken some information from the borrower, and made a tentative ....
- U.S. mortgage terminology - pre-approvalPre-approvalIn lending, pre-approval has two meanings:1. The first is that a lender, via public or proprietary information, feels that a potential borrower is completely credit worthy enough for a certain credit product, and approaches the potential customer with a guarantee that should they want that product,...
- U.S. mortgage terminology - FHA loanFHA loanAn FHA insured loan is a Federal Housing Administration mortgage insurance backed mortgage loan which is provided by a FHA-approved lender. FHA insured loans are a type of federal assistance and have historically allowed lower income Americans to borrow money for the purchase of a home that they...
- Relating to the U.S. Federal Housing Administration - VA loanVA loanA VA loan is a mortgage loan in the United States guaranteed by the U.S. Department of Veterans Affairs . The loan may be issued by qualified lenders....
- Relating to the U.S. Veterans Administration. - eMortgagesEMortgagesAn eMortgage is an electronic mortgage where the loan documentation is created, executed, transferred and stored electronically.In the United States eMortgages are made legally enforceable by the Electronic Signatures in Global and National Commerce Act and the Uniform Electronic Transactions Act...
- Location Efficient MortgageLocation Efficient MortgageLocation Efficient Mortgage is a mortgage available to people who buy a home in locations where they don't need to rely on automobiles as much or at all for transportation. Location efficient mortgages allow people to buy more expensive homes than they normally would be able by factoring in the...
- a type of mortgage for urban areas - Predatory mortgage lending
Legal details
- DeedDeedA deed is any legal instrument in writing which passes, or affirms or confirms something which passes, an interest, right, or property and that is signed, attested, delivered, and in some jurisdictions sealed...
- legal aspects - Mechanics lienMechanics lienA mechanic's lien is a security interest in the title to property for the benefit of those who have supplied labor or materials that improve the property. The lien exists for both real property and personal property. In the realm of real property, it is called by various names, including,...
- a legal concept - PerfectionPerfection (law)In law, perfection relates to the additional steps required to be taken in relation to a security interest in order to make it effective against third parties and/or to retain its effectiveness in the event of default by the grantor of the security interest...
- applicable legal filing requirements
External links
- FHA loans (Department of Housing and Urban Development)
- Mortgages: For Home Buyers and Homeowners at USA.gov
- Financial Consumer Agency of CanadaFinancial Consumer Agency of CanadaThe Financial Consumer Agency of Canada is an independent government agency of the Government of Canada. FCAC provides consumer information and oversees financial institutions to ensure that they comply with federal consumer protection measures. Created in 2001, the Agency investigates cases of...