What Is a Mortgage?
A mortgage is the biggest financial obligation most people will ever assume. It is a loan secured by the property purchased with it, which means that if the borrower fails to repay the debt (with interest) by the end of the mortgage term, the lender can take possession of the home. Typically, this is done through foreclosure, or in a more peaceful manner, by selling the property to pay off the debt.
Most residential homes are bought with a combination of cash from the buyer and a loan from a bank or other lender. The money from the sale is used to cover the cost of the home, while the remaining balance of the purchase price is borrowed by the buyer and paid back with interest over time. During the time that a mortgage is outstanding, the lender has rights to the property that are superior to those of any other creditors. This ensures that if the home is sold to pay off the mortgage debt, the lender will receive all of the proceeds from the sale, rather than some of them.
Many lenders will ask borrowers to write letters of explanation in addition to reviewing their credit and income information during the mortgage approval process. This is especially true if the borrowers have substantial debt and/or poor credit, as the letter can provide more insight to the lenders than a credit score or other basic financial metrics alone. This helps to give the lender a better understanding of a borrower’s financial health, which can be important for their ability to repay a mortgage loan.
There are many different kinds of mortgages, from those secured by commercial real estate to those that are backed by government-sponsored enterprises. In general, however, all mortgages share certain common characteristics:
Borrowers usually begin their mortgage lending journey by applying to one or more lenders for a loan to buy a house. They must submit a variety of documentation to support their financial capacity to afford the mortgage, including income and expense documents, investment and savings account statements, tax returns, employment history, and credit report. The lenders then analyze the documentation to determine if they will lend the money and at what rate.
Once a borrower is approved for a mortgage, the terms of the loan are set out in a written agreement called a mortgage deed or trust. The mortgage deed typically entails a fee simple interest in the property and a promise to repay the loan, with interest, at the end of the term.
There are some variations in how a mortgage is funded and how it is repaid, depending on locality, law, and prevailing culture. For example, some countries allow mortgages to be funded through the banking sector or the capital markets by converting pools of mortgages into fungible bonds that can be sold in small denominations. There are also variations in how the cost of the loan is determined, such as through a fixed interest rate or an adjustable interest rate, and how it is repaid, such as through a lump sum redemption at the end of the mortgage term or a continuous stream of payments until the mortgage is fully paid off.