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According to
Anglo-American property law, a mortgage occurs when an owner (usually of a
fee simple interest in realty) pledges his 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. Although the
terminology and precise forms will differ from country to country, the basic
components tend to be similar: |
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• 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 interest 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 insurance and mortgage insurance, 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 bank or other financial institution.
Lenders may also be investors who own an interest in the mortgage through a
mortgage-backed security. 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
server.
• 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.
• Interest: a financial charge for use of the lender's money.
• Foreclosure or repossession: 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 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) risky 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.
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