Mortgage law

A mortgage (from Law French, lit. "dead pledge") is a device developed in the common law world, whereby the ownership of property is passed from one person, the mortgagor, to another, the mortgagee, in return for the loan of money. The mortgagee is prevented from exercising his rights of ownership by the rules of equity so long as the interest on the loan is paid.

Historically this distinguished a mortgage from other legal devices such as a lien, charge or pledge, but in most common law jurisdictions the operations of mortgages has been changed so that these concepts have merged to a greater or lesser extent.

In modern society it is used as a method by which individuals or businesses can buy residential or commercial property without paying the full value immediately.

Operation of the mortgage

The borrower (also called the mortgagor) uses a mortgage to pledge real property to the lender (also called the mortgagee) as security against the debt (also called hypothecation) for the rest of the value of the property. In legal terms, the creation of a mortgage gives the legal title of the land to the mortgagee and an equitable title (called "equity of redemption") to the mortgagor. The legal title, however, only exists as a security for a debt and does not convey any title or powers associated with real property.

The mortgage instrument contains two parts:

the mortgage, which is the pledge
the promissory note (or simply note) which is the actual evidence of the debt and promise to repay

To protect the lender, a mortgage is recorded in the public records creating a lien (when there are multiple liens, order of recording determines priority). 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 the lien of the mortgage is prior to anyone else's claim. 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.

History

At common law, a mortgage was a conveyance of land that on its face was absolute and conveyed a fee simple estate, but which was in fact conditional, and would be of no effect if certain conditions were not met --- usually, but not necessarily, the repayment of a debt to the original landowner. Hence the word "mortgage," Law French for "dead pledge;" that is, it was absolute in form, and unlike a "live gage", was not conditionally dependent on its repayment solely from raising and selling crops or livestock, or of simply giving the fruits of crops and livestock coming from the land that was mortgaged. The mortgage debt remained in effect whether or not the land could successfully produce enough income to repay the debt. In theory, a mortgage required no further steps to be taken by the creditor, such as acceptance of crops and livestock, for repayment.

In many U.S. states, however, a mortgage has been converted by statute to a device for creating a security interest in land. When the landowner fails to perform on the obligation secured by the mortgage, the mortgage holder may file a foreclosure to cause the property to be sold at auction, usually by the sheriff.

In 2003, total U.S. residential mortgage production reached a record level of $3.8 trillion through record low interest rates (though these continue to vary according to credit rating [1]).

Mortgage finance industry

Mortgage lending is a major category of the business of finance in the United States of America. Mortgages are commercial paper and can be conveyed and assigned freely to other holders. In the U.S., the Federal Housing Administration administers the programs colloquially known as "Ginnie Mae", Fannie Mae and "Freddie Mac" (also known as the GSEs or government sponsored entities) to foster mortgage lending and thus to encourage home ownership and construction. These programs work by buying a large number of mortgages from banks and issuing (at a slightly lower interest rate) "mortgage-backed bonds" to investors known as MBS or Mortgage Backed Securities.

This allows the banks to quickly relend the money to other borrowers (including in the form of mortgages) and thereby to create more mortgages than the banks could with the amount they have on deposit. This in turn allows the public to use these mortgages to purchase homes, something the government wishes to encourage. The investors, meanwhile, gain low-risk income at a higher interest rate (essentially the mortgage rate, minus the cuts of the bank and GSE) than they could gain from most other bonds.

Securitization is a momentous change in the way that mortgage bond markets function which has grown rapidly in the last 10 years as a result of the wider dissemination of technology in the mortgage lending world. For borrowers with superior credit, government loans and ideal profiles, this securitization keeps rates almost artificially low, since the pools of funds used to create new loans can be refreshed more quickly than in years past, allowing for more rapid outflow of capital from investors to borrowers without as many personal business ties as the past.

Process (USA)

In the USA, the process by which a mortgage is secured by a borrower is called origination. This involves the borrower submitting an application and documentation related to his/her financial history to the underwriter. Many banks now offer "no-doc" or "low-doc" loans in which the borrower is required to submit only minimal financial information. These loans carry a slightly higher interest rate (perhaps 0.25% to 0.50% higher) and are available only to borrowers with excellent credit.

Sometimes, a third party is involved, such as a mortgage broker. This entity takes the borrower's information and reviews a number of lenders, selecting the ones that will best meet the needs of the consumer.

Loans are often sold on the open market to larger investors by the originating mortgage company. Many of the guidelines that they follow are suited to satisfy investors. Some companies, called correspondent lenders, sell all or most of their closed loans to these investors, accepting some risks for issuing them. They often offer niche loans at higher prices that the investor does not wish to originate.

If the underwriter is not satisfied with the documentation provided by the borrower, additional documentation and conditions may be imposed, called stipulations. The meeting of such conditions can be a daunting experience for the consumer, but it is crucial for the lending institution to ensure the information being submitted is accurate and meets specific guidelines. This is done to give the lender a reasonable guarantee that the borrower can and will repay the loan. If a third party is involved in the loan, it will help the borrower to clear such conditions.

These documents typically required for underwriter review. Many of these are not required for no-doc and low-doc loans.

credit report
1003 -- Uniform Residential Loan Application
1004 -- Uniform Residential Appraisal Report
1005 -- Verification Of Employment (VOE)
1006 -- Verification Of Deposit (VOD)
1007 -- Single Family Comparable Rent Schedule
1008 -- Transmittal Summary
Copy of deed of current home
federal income tax records for last two years
Verification Of Mortgage (VOM) or Verification Of Payment (VOP)
Borrower's Authorization
Purchase Sales Agreement
1084A and 1084B (Self-Employed Income Analysis) and 1088 (Comparative Income Analysis) -- used if borrower is self-employed

Glossary

Adjustable Rate Mortgage (ARM)
Amortization (business)
Fixed-Rate Mortgage (FRM)
Fannie Mae - Federal National Mortgage Association.
Fair Isaac (FICO) - One of the three main credit bureaus. A FICO score of 600 would be similar to a "C" in public school grading or a "C-" in private school grading.
FHLB Advances - Funding provided by Federal Home Loan Banks.
Freddie Mac - Federal Home Loan Mortgage Corporation.
Government Sponsored Entity (GSE) - Private organizations with government charters whose function is to provide liquidity for the residential loan market. GSEs purchase loans from lenders and assume risk for the asset, thereby protecting the investors in the MBS.
Home Equity Loan (HEL)
Homeowners Insurance - Package policy that combines (1) coverage against the insured’s property being destroyed or damaged and (2) coverage for liability exposure of the insured.
Jumbo mortgages - Loans with high risk of default ab initio.
Loan to value (LTV) - Loan Amount / Value of property.
- Combined loan to value (CLTV). All loans outstanding (i.e. 1st & 2nd) / Value of property.
No Income No Asset (NINA)
No Income Verification (NIV) Income is not verified but many times is "Stated" by the applicant borrower.
No Documentation (No Doc) Income or assets are not stated. Typically requires a low LTV and higher credit scores.
Manufactured housing (MH)
Mortgage Insurance (MI)
Mortgage Servicing Rights Mortgage Service Rights (MSR) - The capitalized asset that represents the value of the servicing fees to be realized over the life of the loan. (See also yield to maturity)
Pooling — The process of grouping together mortgage loans with similar characteristics.
Quitclaim deed (QCD)
Real estate appraisal
Second mortgage Additional loan that is subordinate to the primary mortgage
Secondary mortgage market — The market where lenders and investors buy and sell existing mortgages and MBS securities.
Securitization — The process of pooling loans into mortgage-backed securities for sale into the secondary mortgage market.
Verification of employment (VOE)

Mortgage loan types

There are many types of mortgage loans. The two basic types of amortized loans are the fixed rate mortgage (FRM) and adjustable rate mortgage (ARM).

In a FRM, the interest rate, and hence monthly payment, remains fixed for the life (or term) of the loan. In the U.S., the term is usually for 10, 15, 20, or 30 years. In the UK the fixed term can be as short as five years, after which the loan reverts to a variable rate (which makes the loan an ARM).

In an ARM, the interest rate is fixed for a period of time, after which it will periodically (annually or monthly) adjust up or down to some market index. Common indices in the U.S. include the Prime Rate, the LIBOR, and the Treasury Index ("T-Bill"). Other indexes like 11th District Cost of Funds Index, COSI, and MTA, are also available but are less popular.

Adjustable rates transfer part of the interest rate risk from the lender to the borrower, and thus are widely used where unpredictable interest rates make fixed rate loans difficult to obtain. Since the risk is transferred, lenders will usually make the initial interest rate of the ARM's note anywhere from 0.5% to 2% lower than the average 30-year fixed rate.

In most scenarios, the savings from an ARM outweigh its risks, making them an attractive option for people who are planning to keep a mortgage for ten years or less.

A partial amortization or balloon loan is one where the amount of monthly payments due are calculated (amortized) over a certain term, but the outstanding principal balance is due at some point short of that term. A balloon loan can be either a Fixed or Adjustable in terms of the Interest Rate. Many Second Trust mortgages use this feature. The most common way of describing a balloon loan uses the terminology X due in Y, where X is the number of years over which the loan is amortized, and Y is the year in which the principal balance is due.

Other loan types:

Costs involved in a mortgage

Lenders may charge various fees when giving a mortgage to a mortgagor. These include entry fees, exit fees, administration fees and lenders mortgage insurance. There are also settlement fees (closing costs) the settlement company will charge. In addition, if a third party handles the loan, it may charge other fees as well.

UK banks usually charge a valuation fee, which pays for a chartered surveyor to visit the property and ensure it is worth enough to cover the mortgage amount. This is not a full survey so it may not identify all the defects that a house buyer needs to know about. Also, it does not usually form a contract between the surveyor and the buyer, so the buyer has no right to sue if the survey fails to detect a major problem. For an extra fee, the surveyor can usually carry out a building survey or a (cheaper) "homebuyers survey" at the same time.

Guide to buying in the UK from the Royal Institution of Chartered Surveyors

Fixed rate mortgage calculations

First the nomenclature:

I - The stated interest rate, for example, 5%/year. This is not the APR (annualized percentage rate).
m - The number of periods in the time frame of I. I is usually based on a year but it could be based on any amount of time.
i - The interest rate for the compounding period which is needed for the calculation. For example, a real property mortgage is usually based on a monthly period. In this case i=I/12 where I is based on the normal yearly period. In general i=I/m. Also I needs to be a decimal not a percent thus it also needs to be divided by 100.
n - The total number of periods or payments. Things like mortgages usually cover multiple years.
B - The balance, for example, the balance remaining on the mortgage at any point in time.

Mortgage Calculations:

Let B₀ be the original mortgage.
Let B₁, B₂, B₃ etc. be the balance after the first, second, third period respectively.
Obviously, one can think of B₀ as the balance after the zeroth period namely the beginning balance.
P - The mortgage payment.

Now let's write down the balances. First the initial balance, the amount of the mortgage:

B_{0}\,

Now calculate the balance after one period or payment:

B_{1}=B_{0}(1+i)-P\,

During the first period the initial balance has grown by the period interest and has been decreased by the first payment. Similarly:

B_{2}=B_{1}(1+i)-P=B_{0}(1+i)^{2}-P(1+i)-P\,

Again:

B_{3}=B_{2}(1+i)-P=B_{0}(1+i)^{3}-P(1+i)^{2}-P(1+i)-P\,

After n periods or payments we have:

B_{n}=B_{0}(1+i)^{n}-P(1+i)^{n-1}.....-P(1+i)^{2}-P(1+i)-P\,

B_n is set equal to zero. When the mortgage is paid off the balance is zero. Now one can solve for P the payment. Rearranging gives:

B_{0}(1+i)^{n}=P[1+(1+i)+(1+i)^{2}+....+(1+i)^{n-1}]\,

The righthand side is a geometric series where each term is equal to the preceding term multiplied by (1 + i) which is known as the common ratio. See geometric sequence for additional details.

Solving for P gives:

P=B_{0}[i(1+i)^{n}]/[(1+i)^{n}-1]\,

The payment can be readily calculated to the penny with a spread sheet or scientific calculator.

Note: B₀ is just a simple multiplier. Therefore one can do the calculation for a unit of currency such as a dollar and then multiply the result by the amount of the loan. In essence B₀ is just a scale factor. For example think of the loan amount as my dollar where my dollar is just a currency whose exchange rate is just the loan amount difference.

Now let's do some calculations. Mortgages are usually for 10, 15, 20 or 30 years. Interest rates used to be around 9%/year and today around 6%/year. For all calculations B₀ = 1

calculations for i = .09/12 = .0075
years	n	(1 + i)ⁿ	P	nP
10	120	2.451357078	.012667577	1.520109285
15	180	3.838043267	.010142665	1.8256797
20	240	6.009151524	.008997259559	2.15934216
30	360	14.73057612	.00804622617	2.89664136

calculations for i = .06/12 = .005
years	n	(1 + i)ⁿ	P	nP
10	120	1.819396734	.01110205	1.332246023
15	180	2.454093562	.008438568281	1.51894224
20	240	3.310204476	.007164310585	1.7194344
30	360	6.022575212	.005995505252	2.158381891

First calculate (1 + i)ⁿ since it occurs in both the numerator and the denominator. Then complete the calculation for the payment P. In the first case, for each dollar of loan the payment is a little over a penny per month. Multiplying the amount of the payment P by the number of payments n gives the total amount paid. In the case with 9% interest over 15 years, for each dollar of loan the repayment is a little over a dollar and 82 cents. The 1.82 is also the ratio of the repayment amount to the amount of the loan.

Alternatively, for a given payment $P$ , it is possible to solve for the number of periods needed $n$ to repay the loan:

n=\left\lceil -\log _{1+i}\left[1-{\frac {iB_{0}}{P}}\right]\right\rceil \,

where the $n^{\textrm {th}}$ (final) payment will be less than or equal to the others. This is useful for loans with no prepayment penalty, and a mortgagor who wishes to repay the loan as quickly as possible (in order to minimze the interest paid). Of course, for this formula to apply, $P>iB_{0}$ . If $P<iB_{0}$ , this corresponds to a Reverse mortgage; $P=iB_{0}$ corresponds to an Interest-only loan.

Islamic mortgages

Islamic Sharia law prohibits the payment or receipt of interest, which means that practising Muslims cannot use conventional mortgages. However, real estate is far too expensive for most people to buy outright using cash: Islamic mortgages solve this problem by having the property change hands twice. In one variation, the bank will buy the house outright and then act as a landlord. The homebuyer, in addition to paying rent, will pay a contribution towards the purchase of the property. When the last payment is made, the property changes hands.

An alternative scheme involves the bank reselling the property according to an installment plan, at a price higher than the original price.

In the United Kingdom, HSBC was the first major bank to offer Islamic mortgages.

Dutch mortgages

Dutch banks often adopt a scheme that could be considered the very opposite of the islamic one. In a so-called "aflossingsvrije" mortgage, the homeowner only pays the interest, but never pays any of the mortgage sum back. Instead, s/he pays some monthly sum into a savings account — which becomes part of the collateral — and uses the contents of this savings account to pay off the entire debt at once when the amount of money in the account equals the mortgage sum. This exceedingly contrived construction exists only because it ends up creating a larger deductible on the homeowner's income tax. Variants exist where a share account or a life insurance is used instead of a savings account.

Torrens title registration system

Under the Torrens title registration system of land ownership registration, mortgages and easements are recorded on the title at the central registry, so that any buyer knows for certain whether a block of land is subject to a mortgage or not. This is a simple process, which reduces transaction costs involved in the sale of land.

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