When a prospective property purchaser is wanting to purchase a piece of property, they will often require some form of financial assistance to purchase the home. In most cases, the prospective purchaser will seek out a lender, such as a bank or other lending institution, to loan them the money required to purchase the piece of property. The most common form of a property loan arrangement between a prospective purchaser and a lender is known as a mortgage.
A mortgage is legally defined as a type of security interest that attaches to property that is paid with borrowed money. Mortgages are the most common method of financing the purchases of real estate. Mortgagors, also known as the prospective property buyer(s) are the party transferring the interest in land to a mortgagee, which is usually a bank providing the loan or other interest in exchange for the security interest in the land.
It is important to note that there are also government sponsored mortgage lenders, such as the United States Department of Veteran Affairs (“VA”), the United States Department of Housing and Urban Development (“HUD”), and the Federal Housing Administration (“FHA”) which also provide funds to prospective home buyers that qualify for their programs.
In simple terms, a mortgage allows a prospective property buyer the funds necessary to purchase a piece of property, and in exchange that buyer gives the bank an interest in the property being purchased. Then, should the purchaser fail to pay back the money loaned to them, the bank will have the interest necessary to foreclose on the loan and sell the property in order to pay off the loan.
What Is an Example of a Typical Loan Process?
As mentioned above, a loan for the purchase of real estate typically involves two parties: (1) a borrower, also known as the mortgagor, who is seeking financing to purchase the real estate; and (2) a lender, also known as the mortgagee, who lends the money to a borrower for the purchase of real estate in exchange for payments of interest on top of the amount loaned.
Borrowers will often seek out lenders based on who can offer them the least amount of interest on a loan paid out over the life of the loan. Interest rates are important when it comes to real estate loans. Once again, lenders profit from real estate transactions by arranging for the borrower to pay back additional money over the total amount of money they are seeking to borrow. Then, the difference between the money that is lent to the borrower and what is expected to be returned to the lender is known as interest.
The interest on real estate loans is determined through an interest rate, which is often expressed as a percentage of the total amount of the loan. While some real estate loans have fixed interest rates, other loans have variable interest rates, which change over time. It is important to note that there are various laws regarding interest rates, including laws regarding what can be charged and how the interest rates can be changed.
Once the borrower selects a lender, they will submit an application to the lender. Once a lender has received a loan application, the lender will then conduct a risk evaluation of the borrower to determine whether or not they should move forward with the process to eventually grant a mortgage loan.
The risk evaluation process will consist of the borrower submitting proof of their ability to repay the loan, such as their income, current account balances, previous two years of tax returns, complete list of other assets, complete list of debts, along with a report of their credit history. Borrowers with a longer credit history and higher credit score will often get a better interest rate offer from the lender.
If everything checks out during the risk evaluation process, the lender will then offer a loan to the borrower, including a stated interest rate, by sending them loan disclosures to review. The loan commitment/disclosures will contain very important details of the loan such as the total loan amount, repayment terms, interest rate, closing costs, and other pertinent conditions for the loan. If the borrower agrees to everything in the disclosures, both parties will then move towards closing on the loan by entering into a contract.
How Many Different Types of Mortgages Exist?
As noted above, there are several different types of mortgages that exist, including but not limited to:
- Jumbo Mortgages: Jumbo mortgages are a type of loan that exceeds the max loan limits set by the Federal Housing Finance Agency (“FHFA”). Jumbo loans are not eligible to be purchased, guaranteed, or securitized by Fannie Mae or Freddie Mac, and are typically used to finance luxury properties and homes in competitive real estate markets. Jumbo mortgages require specific requirements to be followed, and have specific tax implications. The 2022 loan limit set by FHFA is $647,200 for most of the United States;
- Two-Step Mortgages: Two-step mortgages are mortgages that involve both fixed rate and adjustable rate mortgages in one mortgage. Two-step mortgages usually begin with a fixed-interest rate, typically stated in an increment of 5, followed by an adjustment which leads to a new fixed-rate for the remaining term of loan. Two-step loans are ideal for those that do not possess good credit;
- Assumable Mortgages: An assumable mortgage is a type of loan arrangement where an outstanding mortgage, along with its terms, are transferred from the current mortgagor to a prospective buyer. Thus, the prospective buyer assumes the previous mortgagor’s debt, and the buyer does not have to obtain their own mortgage. Only certain loans may be assumable. Importantly, USDA, FHA, and VA loans are assumable loans, when certain conditions are met;
- Subprime Mortgages: Subprime mortgages are mortgages given to borrowers with poor credit scores or other financial challenges. Because the risk of the loan is higher for the lenders, the lender will offset the risk by charging a higher interest rate to offer the loan;
- Biweekly Mortgages: A Biweekly mortgage is a mortgage where the borrower makes payments every two weeks, for a total of 26 half payments. The result is that 13 full payments are made over a 12 month period. Making an extra payment per year provides significant savings in the interest paid on the loan. However, this payment arrangement is not good for a borrower who cannot make frequent payments;
- Balloon Mortgages: A balloon mortgage is not as common as other types of mortgages. Balloon mortgages require the borrower to pay a substantial payment of the principal of the loan in a single payment at the end of the loan;
- Fixed Rate Mortgages: A fixed rate mortgage is a loan where the interest rate and the amount a borrower pays each month remain the same over the entire mortgage term. Fixed rate mortgages are traditionally 15 years or 30 years. Lenders often offer variations on fixed rate mortgages, including a fixed fiver or ten year rate, and then variable interest rates for the remainder of the loan, or a balloon payment at the end of the mortgage term;
- Adjustable Rate Mortgages: An adjustable rate mortgage has an interest rate that fluctuates according to the market interest rate at that time. In the beginning of the mortgage term, the rate is typically a lower rate than the market. Over time, the rate on the loan will then go up and down in response to the market; and/or
- Interest-Only Mortgages: Interest-only mortgages are also not common mortgages. With an interest-only mortgage, a borrower pays only the interest amount each month on their mortgage, without paying any of the principal. Then, at the end of the mortgage term, the borrower will refinance to pay off the principal loan amount. Although these loans seem affordable, the borrower must at some point pay off the principal to own the home.
Do I Need An Attorney For Mortgages?
If you are involved in a real estate transaction, you should consult with an area mortgage attorney. An experienced and local real estate lawyer will be best suited to helping you understand your state’s specific laws surrounding mortgages, as well as what your best option is based on your specific circumstances.
Additionally, your real estate lawyer will also be able to review the documents related to the mortgage, and advise you of your best course of action. Finally, an attorney will also be able to represent you in court, as needed, should any issues arise requiring legal intervention.