What is a Mortgage?

The term "mortgage" is a type of loan that a borrower takes to maintain his house or any form of assets and he agrees to return the amount in a particular period of time to the lender usually in a series of regular equally monthly, quarterly, or half-yearly payments.

The mortgage deed is generally drafted to document the transaction between the lender and the borrower which contains certain clauses agreed to by the parties to the deed.

What is a Mortgage Deed and What are its Essential Elements?

The mortgage deed is a legal document that contains the terms and conditions agreed by the parties. The drafting of the deed gives the lender certain rights and interest over the property which was initially held by the borrower, as the property is pledged as collateral to the lender. The lender therefore can claim the rights legally over the property if there is any default in payment of loan amount by the borrower.

Essential elements to a Mortgage Deed

a. Parties to the deed: It includes a mortgagor and a mortgagee. The person who transfers the title of the property is called “mortgagor” and the person to whom it is transferred is called “mortgagee”

b. Description of the deed: It signifies the title of the deed in capital letters.

c. Details of the property. It consists of the description of the property such as the location, size, material facts with regards to the property that needs to be disclosed.

d. Habendum: It signifies the rights and the extent of the interest of the borrower and lender over the mortgaged property. The clause also mentions the restriction on the rights offered.

e. Terms and conditions for the repayment of loan amount like the time period, interest rates, etc.

f. The tenure when the lender is entitled to get his property back.

g. Stamp duty, attestation, and the mortgage rate at which the borrower is required to pay interest as per the mortgage deed.

Is registration of a Mortgage Deed required?

The mortgage deed's registration is important for it to give validity and legal status. The deed must be signed by both parties and must be attested by the two witnesses for the validity of the registration. It is necessary to pay the required stamp duty for it to become enforceable by law.

Who are the parties to a Mortgage Deed?

There are typically two parties that are involved in the mortgage.

a. Mortgagor: The "mortgagor" is a borrower who borrows money from the lender and thereby keeps his property as collateral with the lender until the loan and the mortgage payment is made in full. The ownership of the property kept as a mortgage transfer from the mortgagor to the lender until the payment of the loan is made in full. The mortgagor is also required to provide the lender with the proper documentation as and when asked by him to commence the deal.

b. Mortgagee: The "mortgagee" is a lender who lends money to the mortgagor. The ownership of the property gets vested in the mortgagee as soon the mortgage deed comes into effect and in case of any default in payment of the loan amount the mortgagee has the right to sell the mortgaged property to recover his amount. In cases where the mortgage payment is made in full by the mortgagor, the mortgagee is mandatorily required to release the property back to him.

What are the Different Types of Mortgages?

There are six types of mortgage loans that are guaranteed by the U.S government.

A. Conventional Mortgage: A conventional mortgage is a type of loan which is generally given to those borrowers who maintain good credit, have a stable job and income history. It is however not secured or offered by a government entity. In the United States of America, "Fannie Mae or Freddie Mac" are the two enterprises that deal in conventional mortgages, and both the enterprises are sponsored by the government.

B. Conforming Mortgage loans: A conforming loan is a type of mortgage wherein there is a dollar limit set by the Federal Housing Finance Agency (FHFA) and the limit of loan to be disbursed is equal to less than the dollar amount fixed. The borrowers who have excellent credit generally get this loan at a very low-interest rate.,

The baseline limit for this loan for the year 2021 is $ 548,250 for the majority of states in the U.S. Apart from the excellent credit history there are other guidelines that the borrower must adhere to as the size of the payment made upfront and necessary documentation.

As the conforming mortgage loans can easily be sold in the secondary market and can be packaged easily, they are most preferred by the lenders.

C. Non- conforming Mortgage loans: These are the types of loans which cannot be bought or sold by the agencies such as Fannie Mae and Freddie Mac as it does not meet the guidelines set by them and also it exceeds the conforming loan limit and have very high-interest rates. These are also riskier and are often harder to sell for the lenders in the secondary market. The non-conforming mortgage loans are often referred to as "jumbo loans".

D. Government-Insured Federal Housing Administration (FHA) loans: The FHA loans are generally resorted to by low to moderate-income groups when they are unable to qualify for the conventional loans. There are also other reasons for choosing FHA loans such as lowdown payment, less credit score requirements as compared to the conventional loans. The FHA loans however have one drawback that a borrower is mandatorily required to pay upfront and annual "Mortgage Insurance Premium (MIP)" which is a kind of insurance to protect the lender from the default of the borrower during the tenure of the loan. 

E. Government- Insured U.S. Department of Agriculture loans: This is also a kind of home loan provided to the low-income groups in rural areas by the U.S Department of Agriculture (USDA) so that every household can get shelter themselves. The USDA loans are best for households who fall in the low-income groups and cannot afford a conventional loan, as these require very little or no down payment to be made by qualified buyers.

What is Refinancing and how does it work?

The word "refinance" means to revise or replace the terms of an existing loan agreement or a mortgage deed. The refinance usually occurs when the terms of an existing loan agreement with regards to the interest rates, payment schedule, etc. are requested to be revised by the borrower, and refinancing usually takes place when such revision is agreed to by the lender and a new contract or deed comes into effect with the revised terms and conditions.

The refinancing of a mortgage takes place when a borrower takes a new loan to pay off the original mortgage loan. The main reason why a borrower chooses to refinance a mortgage loan is because of the low mortgage rates and mortgage payments. In cases where the borrowers' credit has improved and the market mortgage rates have lowered since they took the first mortgage loan, it is always feasible for the borrower to go for refinancing of the mortgage.

There are different types of mortgage refinance as per the U.S government:

1. Traditional Refinance: It is the most common type and often called as the "rate and term refinance". Its rate and term refinance the homeowners can change their existing loan’s mortgage rate or tenure or both. This refinance helps borrowers to save a considerable amount of money as compared to other refinances.

2. Streamline Refinance: It requires less paperwork as compared to the traditional refinance. The streamlined refinance does not require any credit or income verification and one can qualify for this refinance if they have a government-insured mortgage such as FHA, Veteran’s Administration (VA), or U.S Department of Agriculture loan (USDA).

3. Home Affordable Refinance Program (HARP): It allows individuals to refinance homes up to 125% of the market value, where your home's current value is lower because of it being underwater.

4. Cash-in Refinance.  This is a kind of refinance wherein the borrower has an option to make a comparatively larger payment towards the principal amount before the closing of the loan which enables him to refinance it with lower monthly payments and mortgage rates. 

5. Cash-out Refinance. In this, the borrower is allowed to get some cash using the home mortgage. It works on the mechanism that herein old mortgage is replaced with the new one but for a larger amount than the one previously owed on the loan already existing thereby enabling the borrowers to also get some cash.

6. No Closing Cost Refinance: This borrower is not required to bear the closing cost for getting a new loan. The no closing cost refinance however does not affect the monthly interest rates but it normally increases the borrower's monthly payments.

Formulas

The formula for calculating monthly payments for the mortgage.

Here,

M = Monthly payments

P = Principal Amount.

r = Interest rate (Annual)

n = Number of monthly payments.

Practice Problem

Example: A mortgage loan of $100,000 is taken for 10 years at 6% interest rate to be repaid monthly.

The monthly payment using the above formula would be $1,110, however, if homeowner's insurance and property tax of $66 each is included, the monthly payments would come down to $1,242.

Assuming that the 1st mortgage payment is due on date April 30th, 2021

Payment Schedule

*The above payment schedule is calculated for a period of 9 months, in the same manner, the calculations will continue until the remaining balance is $0 at the end of the 120th month.

Note 1. The remaining balance is the difference between the previous years remaining balance minus the current year's principal amount.

Note 2. The interest amount for the next year is calculated by taking the remaining balance amount and not the loan amount. The interest amount above has been calculated at a 6% annual interest rate, then dividing the resultant by 12 to get the monthly interest rate.

Note 3. The principal amount is the difference between the monthly payments and the interest amount for the current year.

Context and Applications

This topic is significant in the professional exams for both undergraduate and graduate courses, especially for

• MBA
• BBA
• B. Com
• B. Com (Hons)