A common misconception is that the word "mortgage" comes from the same Latin word which gave us mortuary, because most borrowers will be dead before their loan is paid off. This is not true.

It comes from the French term "mort gage," or "dead pledge." You have pledged your house as collateral for the loan. When you've paid the loan off, the signed documents are returned to you and the pledge is legally dead.

You may be apt to hear socialistic ramblings about The System run by The Man trying to keep you down, man. I would say, "Nonsense." In these days of low interest rates and 15-year mortgages, it's more than likely that you'll actually own your home one day and be able to trade it in for a better one, if you choose. (They say you should be able to buy your third home with cash.)

Folks who rant about paying interest on mortgages are the same ones who tell you to buy Term Life Insurance rather than some form of Whole Life or Universal Life and invest the difference. The problem with this idea is that 8 out of 10 people with this intention never get around to the second part of the equation. Thus, Social Security for the masses instead of self-reliance, like in the good ol' days.

A plain vanilla mortgage security is a bond backed by a pool of home mortgages. The investor recieves his or her portion of the mortgage payments that the borrowers repay on a monthly basis. This means that the cash flows that are provided by the bond are mostly interest payments at first, and over time pay out more and more principal.

Mortgage securities contain embedded options. When interest rates fall, homeowners refinance and prepay the mortgage. This leaves the bondholder in a lower interest rate environment with a fistfull of cash and no tasty (higher yielding) bond. Conversely, when the interest rates rise, people quit moving and refinancing, and the bond's duration just streches out. This leaves the bondholder with a sucky bond with a low coupon that is going to be around forever.

To compensate for all the junk mortgage investors have to deal with, the yields on mortages are higher than bonds without options.

Investment bankers can create all kinds of exotic options that slice and dice the cashflows into more predictable and more risky securities.

A loan specifically for the purchase of a piece of real estate. For most people, a mortgage is by far the largest loan they will ever have to ask for. Because of this, and because of the unique nature of real estate as property, mortgages have a set of laws and regulations which are totally unique in the financial world.

Most mortgages will allow you to roll property taxes, assessment fees, and other costs often associated with buying real estate together with the actual purchase price of the property. This is a simple way to simplify the costs of making the purchase, and is almost always a good idea. The cost of those fees and taxes is nominal compared to the cost of the property itself, anyways.

Contrary to what yaqub0r asserts, however, a mortgage is not a scam. Like any other loan, you eventually end up paying far more money than you borrowed. However, real estate is one of the few major purchases you can make that is almost guaranteed to appreciate in value, provided you take care of your purchase. A well-handled mortgage can actually make you money if you hold on to the property for long enough, although in the financial world "long enough" usually means several decades. In addition, purchasing a home will almost always cost less over time than renting property, provided you stay in one place for a number of years.

Choosing a mortgage is a tricky task. It is a huge commitment (because of course, Your home is at risk if you do not keep up repayments on a mortgage or other loan secured on it.) As there are so many different types of mortgage to pick from it is worth getting independent financial advice in order to find the right mortgage for you, the property and the current financial climate.

You will find that there are plenty of people willing to help you find a mortgage. The Estate agent (Americans might refer to one of these as a Real estate agent or even a Realtor) representing the vendor (seller) of the house will be keen to ask if you have a mortgage. Other than satisfying themselves that you are a serious buyer, with money behind you, they are also hoping to make a little extra money by acting as a mortgage broker. The broker you use (either a traditional financial advisor or an in-house estate agent mortgage advisor) is not paid by the client, but instead receives a finder's fee from the lender. As a house-buyer you should never have to pay for mortgage advice.

Types of mortgage

  • Variable

    The most traditional form of mortgage is a variable rate mortgage.. The rate is the lender's SVR (Standard Variable Rate, see the list of mortgage jargon below for more details). These rates can go up and down whenever and however the lender wants. Usually they pretty much follow the national base rate of interest. Compare to Tracker mortgages.

  • Discount

    A discount mortgage is one in which a discounted rate (a certain percentage lower than the lender's regular SVR) is agreed for a fixed period of a few years.

    Discounts are sometimes stepped. You might, for example, find a stepped discount mortgage, with a 1% discount off the lender's SVR in the first year, 0.5% in the second year and a 0.25% discount in the third year.

  • Fixed rate

    A fixed rate mortgage sets an unchangeable interest rate, fixed for a certain period (usually 3 to 5 years). For the borrower these mortgages eliminate the uncertainty of monthly repayments which might become more expensive if interest rates go up. The trade off is that if interest rates were to go down during the fixed period, you would be missing out on a cheaper rate. Clearly choosing a mortgage is largely to do with predicting the future of both the financial and housing markets.

  • Capped

    Capped rate mortgages set, for a fixed period, a maximum rate above which the lenders variable interest rate will not climb. If the variable rate is below the capped rate, the variable rate will be used instead. Clearly, the mortgage company are not a charity, so the cap will be set to take into account what the lender believes interest rates will do during the capped period. However, if you are worried about interest rates rising beyond your ability to repay, a fixed rate or capped mortgage might be the way forward.

    Capped rate mortgages sometimes also have a minimum rate of interest attached. This is sometimes referred to as a 'cap and collar' mortgage (the cap is the maximum and the collar is the minimum rate).

  • Tracker

    The interest rate for a tracker mortgage is linked to the national base rate of interest rather than the mortgage company's SVR (standard variable rate). Any decrease in the base rate is 'tracked', or matched, immediately by the mortgage's rate, even though the lender's normal variable rate might not have gone down.

    Of course, the base rate might go up and your mortgage's interest rate would go up with it. On the bright side, if you'd picked a variable rate mortgage you can be sure that the lender's SVR would have gone up by at least the same amount. Tracker mortgages are good for people who believe that the base rate will drop over a period of time, and who want to take advantage of every tiny drop as it happens.

  • Endowment

    Less popular these days, an endowment mortgage is one in which the borrower pays off only the interest during the term of the mortgage. The remaining loan, which is to say the capital, is paid off with the proceeds of an endowment policy (or some other investment) which matures at the same time.

  • Current Account Mortgages

    Current Account Mortgages, or CAMs are the most modern and flexible of mortgages. They usually allow you to make overpayments and even underpayments of your mortgage, great news if you get a big bonus and don't want to be penalised for paying off a chunk of your debt, or if your income is irregular and some months you can only afford to pay lass than usual. Mortgage lenders offering CAMs have begun to offer many options. One is an 'offset' mortgage, where you also link your savings account with your mortgage. These savings are offset against the mortgage, meaning that rather then earn interest on your savings you instead use that interest to pay off the mortgage. You could have done that by siphoning the interest off the top of your regular savings account of course, but this was the lender will give you the interest at the same rate as the mortgage, which is sure to be a higher rate than most savings accounts will give you.

There are many more types of mortgage, this list represents only the common ones. However like ice cream flavours, sometimes they are just the same things in different combinations. For example, you might see a stepped discount tracker with a cap and collar.


Mortgage jargon

Mortgage lenders, use plenty of very specialised jargon. Anyone looking at mortgages will be expected to learn several new acronyms. To confuse matters, different companies will use different (but synonomous) terms. Here is an attempt to clarify some of it.

APR
Annual Percentage Rate
The fairest way to compare one mortgage with another is to compare their APRs. It includes not only the interest rate (calculated for a year) but also any charges and arrangements fees charged by the lender.

SVR
Standard Variable Rate
The rate the mortgage lender uses for variable rate mortgages. This rate of interest is always higher than the base national interest rate and can change whenever the lender wants it to. Some lenders have agreements, such as "our SVR will never be more than 1% above the base rate". This, while reassuring, should not be confused with a tracker mortgage in which the interest rate is linked directly to the base rate, giving the borrower the immediate benefit of any base rate reduction.

Confusingly, you might also hear it called the lender's 'basic rate'.

LTV
Loan to Value
The 'loan to value' of a mortgage is the amount of the loan expressed as a percentage of the value of the property against which that loan is secured. This equates to the (inverse of the) size of the deposit. For example, a 90% loan-to-value mortgage on a ?100,000 house would require a 10% (?10,000) deposit..

Mortgage lenders often describe the minimum deposit required in terms of the maximum LTV. While many will not lend over 95%, some will offer 100% and even 125% mortgages. You should generally expect to pay lower a lower APR on a mortgage with a lower loan-to-value.

MIG / MIP / MIF
Mortgage Indemnity Guarantee / ... Premium / ... Fee
The MIG is a fee which the borrower pays to the mortgage lender. The lender uses it to insure themselves against potential losses caused by the borrower defaulting on the mortgage. The MIG is sometimes paid upfront but is more usually added on top of the borrowed amount. It is calculated differently by different companies, and can be anything from a few hundred pounds to a couple of thousand. If you redeem (pay back or re-mortgage) before the full term is up, you may also have to pay the MIG in full.

Here's how it works.

If you are unable to make repayments on a mortgage then the lender repossesses your home. If they sell it on for a loss (quite likely, as they will be in a hurry to get rid of it) then the insurance they purchased with your MIG will pay for any shortfall. So you'd think it was sensible to pay the fee to prevent problems if you're house is repossessed, right? Sadly not. In these situations, the insurance company can and will come after you to recoup their losses. You pay the MIG to protect the mortgage lender, not yourself.

MIGs are becoming less common except on mortgages with a high loan-to-value. There is no advantage (to you, the borrower) in picking a mortgage which includes a MIG over one which does not.

Redemption penalty
When a mortgage is paid off early (either because the borrower has become unexpectedly wealthy or, more commonly, because they are re-mortgaging to find a better interest rate), a penalty fee is usually imposed. This penalty is calculated differently by different lenders, but will often be a percentage of the remaining loan. Redemption penalties are so significant that borrowers consider themselves 'locked in' to the mortgage for the period in which the penalty is payable.

This lock-in period is, for most people, only a few years, and usually ends at the same time as any fixed or capped rate, or discounted rate scheme. Sometimes though, redemption penalties are applicable even after the mortgage has reverted to the lender's variable rate. An extended tie-in period which lasts for longer than the scheme is known as 'overhang', and can used to lock borrowers in to the mortgage after it has ceased to be the cheapest option.

Redemption penalties are very common. As long as you are comfortable that, during the period in which the penalty is applicable, the deal you are getting is a good one then, only exceptional circumstances will necessitate you paying it.

Overhang, however, is scary and to be avoided. Many advisors would ignore mortgages with on overhanging tie-in period. When comparing cheap-looking deals (for example, hugely discounted rates for a couple of years, with an initial cash-back lump sum) be sure to look out for overhang. These offers will sometimes have hugely overhanging redemption penalties. Some good questions to ask are:

  1. When the discount runs out, what interest rate will you be paying?
  2. Is that interest rate variable, capped or fixed?
  3. Is the interest rate linked to the base rate of inflation, or can that interest rate go up whenever the lender feels like it?
  4. If you find a better deal, how much will to cost to redeem this mortgage?
  5. How long will it be before you can redeem without paying that penalty?

Term
The length of time over which the mortgage will be repaid. The average mortgage has a term of 25 years. During this time, compound interest means you pay back almost double what you borrowed.

Recently there has been some much publicised concern about 50 year mortgages. Over 50 years the total amount repaid is much more painful, not to mention the fact that you repay the loan for pretty much your entire life.

Valuation
A survey of the property undertaken by the lender to assess its value. A valuation is the only survey strictly required by most mortgage companies. However, unless the house is brand new it is also worth paying for the more detailed home buyers report or even, with very old properties, a structural survey. These two surveys will cost more but will involve a deeper inspection of the property and very detailed feedback on any work which the property requires.



As I've never tried to buy a house in another country, there might be a British slant to this writeup. While I'm sure the basic concepts are universal, if you think I need to add something, or clarify some local aspect of this writeup, do let me know.

Mort"gage (?), n. [F. mort-gage; mort dead (L. mortuus) + gage pledge. See Mortal, and Gage.]

1. Law

A conveyance of property, upon condition, as security for the payment of a debt or the preformance of a duty, and to become void upon payment or performance according to the stipulated terms; also, the written instrument by which the conveyance is made.

It was called a mortgage (or dead pledge) because, whatever profit it might yield, it did not thereby redeem itself, but became lost or dead to the mortgager upon breach of the condition. But in equity a right of redemption is an inseparable incident of a mortgage until the mortgager is debarred by his own laches, or by judicial decree.

Cowell. Kent.

2.

State of being pledged; as, lands given in mortgage.

Chattel mortgage. See under Chattel. -- To foreclose a mortgage. See under Foreclose. -- Mortgage deed Law, a deed given by way of mortgage.

 

© Webster 1913.


Mort"gage, v. t. [imp. & p. p. Mortgaged (?); p. pr. & vb. n. Mortgaging (?).]

1. Law

To grant or convey, as property, for the security of a debt, or other engagement, upon a condition that if the debt or engagement shall be discharged according to the contract, the conveyance shall be void, otherwise to become absolute, subject, however, to the right of redemption.

2.

Hence: To pledge, either literally or figuratively; to make subject to a claim or obligation.

Mortgaging their lives to covetise. Spenser.

I myself an mortgaged to thy will. Shak.

 

© Webster 1913.

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