The simple explanation of a mortgage is that it is a leveraged secured loan against a piece of real estate. It is paid off in monthly payments that are spread out over many years (25+ years).
This simple explanation is really all most people care to know, but to really understand what a mortgage is, then you must understand a bit about the process of creating a mortgage.
The Mortgage Creation Process
When a financial corporation is created, the company’s first goal is to raise capital for lending. This is completed by the banks offering bonds to retail investors to shore up capital. These bonds have interest rates based on supply and demand of the products. The mortgage rates are then based on a spread above the going bond rates. The mortgage rates must take into consideration overhead, revenue, supply and demand, and hedged bond rates.
After the mortgage rate is set, then the lender can offer the product to the market. The lender will determine a list of qualification criteria that the borrower must meet to get approved. This criteria is higher or lower based on the interest rates offered by the lender.
The lender will then seek out approved borrowers. The borrowers will then finalize the deal with their solicitor and the bank will forward the raised capital to the solicitor to disburse.
The lawyer will then register a lien against the property for the financial institution, so if the borrower defaults, then the bank retains the rights to the property. The borrower would make regular repayments until the investment is paid in full.
The bank also has the option to sell the mortgage to other investor’s. The investor’s will achieve greater gains than regular investments but will have a higher risk on the investment.
What does this all mean to the borrower?
The mortgage is a loan that is specifically used when real estate is involved. For example, when you are looking to purchase a property, then you will most likely not have enough money in cash to buy it in full. Instead, you may be able to afford five or ten percent of the purchase price only.
This means that in order to purchase the property, you can either save until you can afford it, or you can geta loan for the rest of the money.
The loan is in today’s dollars, and the purchase price of properties usually increases. With property being a limited resource, the value of the land usually increases even if the market value of the house goes down.
The bank will lend you the money if you are approved, and the lawyer will transfer the money to the seller. The bank and the borrower will determine terms of the repayment of the loan, and upon completion of the loan repayment, then the lien will be discharged from the property.
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