In days of the GFC, we hear a lot about interest rates, mortgagee sales and the like, so what exactly is a mortgage? A mortgage is a document which secures a loan against property and is usually registered with the Land Titles Office.
When registered, the mortgagee (the lender) has the right to sell the property to recover the debt if the owner (the mortgagor) is in default. A court order is normally required to get possession of the property to allow a sale.
The GFC has highlighted the fact that in the USA, defaulting borrowers just walk away from their property, and the mortgagee has no right to recover any shortfall if the property does not realise enough to repay the debt. That is not the situation here: almost universally, mortgages contain a "personal covenant", a promise by the mortgagor to pay the debt, and the mortgagor is liable for any shortfall after a sale.
There can be more than one mortgage on a title, but mortgages usually require that a first mortgagee must consent to any further mortgages. If a second or subsequent mortgage is not registered, there will be problems if the mortgagee wants to sell up on a default.
There are many different types of mortgages, and it can be very confusing discussing them, so here are brief descriptions of the main types:
- P & I Mortgage – the most common housing loan. The P & I stands for "Principal & Interest", and the periodic payments will pay interest and reduce the debt. Often for periods such as 25 years, the debt reduction is very slow in the earlier years. The interest rate will often be variable at the lender’s option.
- Fixed Mortgage – a loan for commonly 3 years, with interest only being paid. The interest rate for the term of the loan is normally fixed.
- Reverse Mortgage – a loan usually to retirees, where no repayments of interest or capital are required until death of the owner or a sale of the property. The interest compounds, and so the debt can increase quite markedly. Some lenders will guarantee that the debt will not increase over an agreed percentage of the property’s value. It allows those with a substantial equity in a home to obtain funds for other purposes.
- Fixed Interest Loan – usually a P & I loan, where it is agreed that for a specified time, the interest rate is locked in and cannot be changed. Effectively the mortgagor and the mortgagee are betting on future interest rises or falls. In a climate where interest rates may be rising, a fixed rate loan does give a borrower some protection against increases in periodic payments. If interest rates have fallen, lenders may charge substantial “break fees” to get out of the agreement.