About Mortgages
A mortgage is a device that is used to create a lien on real estate by contract. It is used as a method where which individuals or businesses can buy residential or commercial property without having to pay the full value upfront. The borrower uses a mortgage to pledge real property to the lender as security against the debt for the rest of the value of the property. In legal terms, the creation of a mortgage will give the legal title of the land to the mortgagee and the equitable title to the mortgagor. However, the legal title only exists as a security for a debt and therefore does not convey any title or powers associated real property.
The mortgage instrument contains two sections:
- the actual mortgage, which is the pledge
- the note, which is the evidence of the debt and the promise to repay.
To protect a lender, the mortgage is recorded in public records creating a lien. Mortgage debt is often the largest debt owed by the debtor, therefore banks and other lenders run title searches of the real property to ascertain that the lien of the mortgage is prior to anyone else's claim.
Adjustable Rate Mortgages
An adjustable rate mortgage or variable rate mortgage is a loan that is secured on a property whose interest rate and monthly repayment vary over time. Adjustable rates have the effect of transfering part of the interest rate risk from the lender to the borrower. The borrower can benefit if the interest rate falls and loses out if they rise
Variable rate mortgages are usually the most common form of loan for a house purchase in the United Kingdom but are unpopular in some countries outside the UK. Variable rate mortgages are common in Australia and New Zealand. For those who plan to move within a short period of time i.e. 3-7 years, they can be attractive due to the fact that they usually include a lower, fixed rate of interest for the first 3,5 or 7 years of the loan. After this period the interest rate fluctuates.
Adjustable rate mortgages, like other mortgage, may offer the ability to repay principal (or capital) early without penalty. Early payments of part of the principal will reduce the total cost of the loan (total interest paid), and will shorten the amount of time needed to pay off the loan. Early payoff of the entire loan amount (refinancing) is often done when interest rates drop significantly.
Adjustable rate mortgages are sometimes sold to unsophisticated consumers who are unlikely to be able to repay the loan should interest rates rise, which they often do. In the United States, extreme cases are characterized by the Consumer Federation of America as predatory loans. Protections against interest rate rises include (a) a possible initial period with a fixed rate (which gives the borrower a chance to increase his/her annual earnings before payments rise); (b) a maximum (cap) that interest rates can rise in any year (if there is a cap, it must be specified in the loan document); and (c) a maximum (cap) that interest rates can rise over the life of the mortage (this also must be specified in the loan document).
Due to changes in government policy among many OECD countries, the Federal Reserve Bank (or its equivalent) is now charged with maintaining an inflation rate at a low (at or below 2 percent) level. This policy has made a significant impact on the volatility of adjustable rate mortgages, as the supply of money is more tightly controlled by the Federal Reserve, reducing the frequency and size of fluctuations in the base rate.
Interest Only Morgages
An interest-only mortgage is a loan in which for a set term the borrower pays only the interest on the capital; the capital remains owing. At the end of the term the borrower may renew the interest-only mortgage, repay the capital, or (with some lenders) convert the loan to a principal and interest payment loan at his option. It should be noted that some interest-only mortgages in Canada allow the borrower to pay interest-only, principal and interest, or even principal and interest plus 20% extra.
In the United States, a five or ten year interest-only period is typical. After this time, the principal balance is amortized for the remaining term. In other words, if a borrower had a thirty year mortgage and the first ten years were interest only, at the end of the first ten years, the principal balance would be amortized for the remaining period or twenty years. The practical result is that the early repayments (in the interest-only period) are substantially lower than the later repayments. This enables a borrower who expects to increase their salary substantially over the course of the loan to borrow more than they would have otherwise been able to afford. Interest only loans were popular in the 1920s. Due to the depression and lack of work for the average person, there were many foreclosures during the depression.
Interest-only loans are popular ways of borrowing money to buy an asset that is unlikely to depreciate much and which can be sold at the end of the loan to repay the capital. For example, second homes, or properties bought for letting to others. In the United Kingdom in the 1980s and 1990s a popular way to buy a house was to combine an interest-only loan with an investment in the stock market, the combination being known as an endowment mortgage. The stock market crash of the late 1990s showed this to be a gamble. An interest-only mortgage in Canada can be combined with Corporate Bonds in a Registered Retirement Savings Plan (RRSP)where the plan holder receives a tax deduction, tax deferral and compound interest.
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