Home Mortgages
01. What is a mortgage?
The word mortgage is a general term used to define several different combinations of legal documents that allow you to finance real estate. The actual documents that you will use depend on the state in which the property is located and the type of loan you are getting. Some of the more common documents are: Mortgage, bond, promissory note, deed of trust, security deed and rider.
Regardless of the terminology, a mortgage is a financial claim against real property. You give a mortgage to a lending institution, usually along with a note, which is your personal promise to repay the loan. In return, the lender gives you money. You do not really get a mortgage. As the borrower, you do the mortgaging, and are referred to as the mortgagor. The lender, who takes and holds your mortgage, is called the mortgagee. For simplicity, you can consider deeds of trust and mortgages as usually interchangeable terms on this site.
Deeds of Trust
In many states, loans are secured by a document called a deed of trust. When you sign a deed of trust, you actually transfer ownership of the property to a trustee. The trustee holds the deed to the property in trust until the loan is paid off.
Should a disagreement arise between the borrower and lender, the trustee must settle the dispute according to state law. If the borrower defaults on the loan, the trustee must hold a foreclosure sale to pay off the lender. Exact procedures for foreclosure sales are dictated by state law and are clearly indicated in the deed of trust. A court hearing is not required in most deed of trust states.
Mortgages
In the event of loan default in states that use mortgages, the lender must go to court, argue the case before a judge and obtain formal approval before a foreclosure sale can be held. Obviously, lenders prefer to have loans secured by deeds of trust since the foreclosure process is cheaper and faster than on a mortgage.
02. Loan Formats
Comparing Different Mortgage Programs
All borrowers have different financial circumstances and therefore, there isn't one magical mortgage formula that will somehow resolve everyone's loan problems. Different borrowers require different strategies so we need to have a solid selection process before we can make a wise selection.
When it comes to real estate financial options there have always been a wide variety of choices because conventional loans simply don't work for all borrowers. Typically, conventional loans require too much down payment, have initial monthly payments that are too high, financing that is too long and total interest costs that are too great. To avoid these problems and sometimes cut a better deal, buyers often use alternative mortgage programs.
Just because financing is not based on conventional terms doesn't mean that a loan is irregular in some way. Unconventional mortgages are perfectly legitimate types of financing that can drop interest rates, lower monthly payments and reduce overall mortgage costs. However, be aware that alternative mortgages can also feature large down payments, changing monthly installments, negative amortization and interest rates that rise and fall randomly over the term of the loan.
The point is that just because alternative loans differ from conventional loans does not mean that such differences are necessarily negative. All loans are simply financial tools that are useful in some situations and inappropriate in others. Deciding on a specific loan format depends on the circumstances of the buyer and their particular financing requirements.
Compare Individual Loans
Not only should you compare different loan formats and terms, you should always compare loans individually. Here are some points to consider:
- If it is a purchase loan, can it be assumed at its original rate and terms by a qualified borrower?
- How much of a down payment is required?
- Does the loan have a prepayment penalty? If so, what are the terms?
- Are the monthly payments subject to change during the term of the mortgage?
- Is there an initial lower rate? If so, how does it compare to other types of mortgages?
- Is there a limit on the maximum amount of interest that can be charged?
- If it is an adjustable-rate mortgage, what are the index and margin?
- If it is a type of adjustable-rate mortgage, is negative amortization allowed?
- What are the tax consequences of the loan?
- Which type of loan will best serve your long-term needs; say five or ten years from now?