Introduction to Mortgages

┠What is a mortgage?

┠How are mortgages structured?

┠How are FHA and VA mortgages structured?

┠What is a deed of trust?

┠What is a promissory note?

What is a mortgage?

In simple terms, a mortgage is putting up real property (real estate) to secure a loan. This means that if you fail to meet the terms of the mortgage — for example, by failing to make your agreed-upon monthly payments — the lender can sell your house through a process called foreclosure to get back the money you borrowed to buy it.

You should familiarize yourself with certain technical terms used in the mortgage industry.

A mortgage is a two-party document — the mortgagor (borrower) gives the mortgage, and the mortgagee (lender) lends the money. Most people incorrectly say that they are going to "buy a mortgage." The expression has become so common that everyone knows that someone who says it is trying to borrow — not lend — money.

From the Expert

The law classifies your property. Real property, also called real estate, consists of land and those things affixed to land, such as buildings, fences, trees, in-ground swimming pools, or any other attachment. Personal property is generally classified as all property that is not real property. Mortgages cover only real property.

Another term that you should know — which is often used incorrectly — is pledge. To pledge something is to deliver physical possession of it, like if you are getting a loan from a pawnshop. When you do not give up possession, you hypothecate the property — you do not pledge it. Since pledge is a simpler word than hypothecate, it is commonly used — even though not technically correct.

How are mortgages structured?

There are two general ways that mortgages are structured. The structure affects how the foreclosure procedures are performed should you not make your mortgage payments. In title theory states, the lender owns the property and deeds it back to the borrower when the loan is repaid. In lien theory states, the borrower owns the property and the lender has a lien on it. Title theory states are more commonly found in the eastern part of the country, with more lien theory states in the western United States.

In either a title theory state or lien theory state, the general effect is the same. The lender's rights in the property are only for the purpose of securing the loan. If the borrower abides by the terms of the note and mortgage, the lender has no right to interfere with the borrower's use and enjoyment of the property.

Note: There is a third way mortgages are structured, which is a hybrid of title theory and lien theory. It is called the intermediary theory. In an intermediary theory state, the borrower has title, but the lender can take title if there is a default.

From the Expert

A lien is the interest a creditor has in your property. It secures the debt and gives the creditor the legal right to take your property if you fail to meet the terms of your debt agreement. A lien is not a bad thing in and of itself, though, because without the protection liens give lenders, far fewer loans would be made.

The differences in the theories may become important when the borrower fails to abide by the terms of the mortgage loan. The foreclosure process varies from state to state, with some state laws being more favorable to the borrower and some to the lender. Since state laws control the real property located within that state, every person must follow the laws of his or her particular state.

How are FHA and VA mortgages structured?

A lender that makes a loan backed by FHA insurance (insurance issued by the Federal Housing Administration to protect lenders) or a VA guarantee (insurance issued by the Department of Veterans Affairs to protect lenders) must follow the entity's guidelines. Government- backed mortgages are covered in a later chapter.

When the loan is repaid, the lien is released. As a practical matter, it comes down to this — if you make your payments, you will eventually have ownership of your home free and clear. If you fail to make your payments, you will lose your home through foreclosure.