FORMS OF CREDIT: RESIDENTIAL MORTGAGES

(A) WHAT IS A MORTGAGE? A ‘mortgage loan’, usually referred to by lenders and the house-buying public in the UK just as ‘a mortgage’, is a loan in which real property (real estate) is used as a lender’s security for the amount borrowed. A ‘legal mortgage’ on the other hand, is an encumbrance on land, (the definition of which includes buildings), which can be confusing because English speakers refer to both of these things, a type of loan and a legal right in land, simply as ‘a mortgage’. When discussing personal finance, therefore, a mortgage is a secured loan to buy a house; a financial product that can be sold to the customers of a bank in the same way as an ordinary unsecured loan or an overdraft.

(B) THE MORTGAGE AGREEMENT Typically, a borrower who wants to buy a house but who does not have the funds to buy it outright, is granted a mortgage in exchange for a promise that he or she will: (a) repay a certain sum to the lender which includes interest on top of the amount borrowed at an agreed rate; and (b) repay the full amount owed within a certain period of time, for example, within 25 years. The agreement typically states that the borrower will pay back the full amount owed in the form of monthly instalments that consist of repaying a portion of the capital sum or principal sum, which reduces the outstanding balance and the interest due, which is the cost of borrowing the outstanding balance on the principal sum for the past month or year.

A borrower will usually have to save for a deposit of a percentage of the value of the property that he or she wants to buy. This reduces the risk for the lender if house prices drop after the purchase of the property. Some lenders require as much as a 40% deposit (with a 60% mortgage) and the 100% mortgages that were common before the 2008 financial crisis are currently very rare. The global financial crisis of 2008 was largely brought about by lenders in the USA granting 100% mortgages to borrowers who were not capable of repaying them.

(C) OWNERSHIP OF A MORTGAGED PROPERTY In a typical mortgage, the mortgagee (the lender), has an enforceable legal interest in the property. This legal interest can arguably be seen as a right of ownership. However, the mortgagor (the borrower), has the right to redeem the mortgage by a certain date, and as long as the borrower abides by the mortgage loan agreement and keeps up with payments, the mortgagee cannot exercise its right. So, it is accurate to say that the borrower owns the property with the lender having overriding legal rights of ownership if the borrower defaults.

In the UK, the lender will register its legal right in the property with the Land Registry, the central register of the ownership of real estate in England and Wales. The purpose of registering a legal mortgage is to ensure that anybody who subsequently deals with the land has notice that there is an existing mortgage which takes priority over subsequent legal interests.

If the borrower defaults on the loan or breaches the terms of the loan agreement in some other way, the lender can take possession of and sell the secured property to pay off the loan. This process is known as ‘foreclosure’ or ‘repossession’. When a lender forecloses, it means that the lender has terminated the mortgage contract with the result that the property which was given as security against the loan comes into the possession of the lender, allowing the lender to sell the property in order to recover its money.

The lender’s rights over the secured property take priority over those of any of the borrower’s other creditors, which means that if the borrower becomes bankrupt, the other, unsecured creditors will only be repaid from the money raised on a sale of the secured property after the mortgage lender has been repaid in full. At the end of the agreed term the mortgage is redeemed. Redemption usually takes place either upon the final repayment of the amount outstanding or in a lump sum if the borrower decides to sell the property.