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Mortgages)
This
article is about the legal mechanism used to secure the performance of
obligations, including the payment of debts, with property. For loans
secured by mortgages, such as residential housing loans, and lending
practices or requirements, see
Mortgage loan.
A mortgage is the pledging of a property to a lender as a security for a mortgage loan.
While a mortgage in itself is not a debt, it is evidence of a debt. It
is a transfer of an interest in land, from the owner to the mortgage
lender, on the condition that this interest will be returned to the
owner of the real estate when the terms of the mortgage have been
satisfied or performed. In other words, the mortgage is a security for the loan that the lender makes to the borrower.
The term comes from the Old French
"dead pledge," apparently meaning that the pledge ends (dies) either
when the obligation is fulfilled or the property is taken through foreclosure.[1]
In most jurisdictions mortgages are strongly associated with loans secured on real estate
rather than other property (such as ships) and in some cases only land
may be mortgaged. Arranging a mortgage is seen as the standard method
by which individuals and businesses can purchase residential and
commercial real estate without the need to pay the full value
immediately. See mortgage loan for residential mortgage lending, and commercial mortgage for lending against commercial property.
The measurement of a mortgage with regards to cost to the borrower can be measured by Annual Percentage Rate (APR) or many other formulas for true cost such as Lender Police Effective Annual Rate (LPEAR).
In many countries it is normal for home purchases to be funded by a mortgage. In countries where the demand for home ownership is highest, strong domestic markets have developed, notably in Spain, the United Kingdom, the Commonwealth of Australia and the United States.
Participants and variant terminology
Legal systems, while having some concepts in common, employ
different terminology. However, in general, a mortgage of property
involves the following parties.
Mortgage lender
Mortgagee is the legal term for the mortgage lender. The main
function of the mortgage is to provide security to the lender. Given
the large sum of money involved in financing a property, a mortgage
lender will usually want security for the loan that will provide a
claim upon that security and will take precedence over other creditors. A mortgage accomplishes this security.
The lender loans the money and registers the mortgage against the title
to the property. The borrower gives the lender the mortgage as security
for the loan, receives the funds, makes the required payments and
maintains possession of the property. The borrower has the right to
have the mortgage discharged
from the title once the debt is paid. If the mortgagor fails to repay
the loan according to the conditions set forth by the lender, then the
mortgagee reserves the right to foreclose on the property.
Borrower
Mortgagor is the legal term for the borrower, who owes the
obligation secured by the mortgage, and may be multiple parties.
Generally, the debtor must meet the conditions of the underlying loan
or other obligation and the conditions of the mortgage. Otherwise, the
debtor usually runs the risk of foreclosure
of the mortgage by the creditor to recover the debt. Typically the
debtors will be the individual home-owners, landlords or businesses who
are purchasing their property by way of a loan.
Most buyers of real property would have difficulty saving enough
money to make an outright purchase of real estate. The use of debt
increases a buyer's ability to buy through a combination of down payment and debt. As a result a real estate transaction seldom occurs without borrowers relying on borrowed funds.
Borrowing for investment purposes
Aside from the absence of large amount of available money, there are several reasons why an investor (including a buyer of real estate) might borrow funds. Some of these include:
- To diversify investments and reduce overall risk by using only part of the available funds for any one investment
- To invest the borrowed funds at a higher rate of interest (yield) than the borrowing rate; for example, a sum is borrowed at an annual interest rate of 7% and used to invest in a project that returns 10%
- To free up equity for
other purposes; for example, a commercial enterprise may prefer to use
funds to purchase inventory or equipment instead of investing only in
land and buildings.
- To obtain a tax benefit. In some countries (such as Canada),
mortgage interest is not tax deductible, but loans made for investment
purposes are.
Other participants
Because of the complicated legal exchange, or conveyance,
of the property, one or both of the main participants are likely to
require legal representation. The terminology varies with legal
jurisdiction; see lawyer, solicitor and conveyancer.
Because of the complex nature of many markets the debtor may approach a mortgage broker or financial adviser to help them source an appropriate creditor, typically by finding the most competitive loan.
The debt is, in civil law jurisdictions, referred to as hypothecation, which may make use of the services of a hypothecary to assist in the hypothecation.
Default on Subdivided Property
When a tract of land is purchased with a mortgage and then split up
and sold off, then the "inverse order of alienation rule applies" to
find out who will be liable for the default.
Basically, when a mortgaged tract of land is split up and sold off,
then upon default, the mortgagee forecloses and proceeds against lands
still owned by the mortgagor, then liability attaches in a backward
fashion, or in an 'inverse order' as they were sold. So if A acquires a
3-acre (12,000 m²) lot by mortgage then splits up the lot into 3 1 acre
lots (A, B, and C), and sells lot B to X, and then lot C to Y,
retaining lot A for himself then, upon default, the mortgagee will go
after lot A, the mortgagor, and if that sale does not satisify the
default, then the owner of lot C will be liable, then the owner of lot
B. The idea is that the first purchaser should have more equity and
subsequent purchasers receive a diluted share.
Legal aspects
There are essentially two types of legal mortgage.
Mortgage by demise
In a mortgage by demise, the creditor becomes the owner of the
mortgaged property until the loan is repaid in full (known as
"redemption"). This kind of mortgage takes the form of a conveyance of
the property to the creditor, with a condition that the property will
be returned on redemption.
This is an older form of legal mortgage and is less common than a
mortgage by legal charge. In the UK, this type of mortgage is no longer
available, by virtue of the Land Registration Act 2002.
Mortgage by legal charge
In a mortgage by legal charge or technically "a charge by deed expressed to be by way of legal mortgage",[2]
the debtor remains the legal owner of the property, but the creditor
gains sufficient rights over it to enable them to enforce their
security, such as a right to take possession of the property or sell it.
To protect the lender, a mortgage by legal charge is usually
recorded in a public register. Since mortgage debt is often the largest
debt owed by the debtor, banks
and other mortgage lenders run title searches of the real property to
make certain that there are no mortgages already registered on the
debtor's property which might have higher priority. Tax liens,
in some cases, will come ahead of mortgages. For this reason, if a
borrower has delinquent property taxes, the bank will often pay them to
prevent the lienholder from foreclosing and wiping out the mortgage.
This type of mortgage is common in the United States and, since the Law of Property Act 1925,[2] it has been the usual form of mortgage in England and Wales (it is now the only form — see above).
In Scotland, the mortgage by legal charge is also known as standard security.
In Pakistan, the
mortgage by legal charge is most common way used by banks to secure the
financing. It is also known as registered mortgage. After registration
of legal charge, the bank's lien is recorded in the land register
stating that the property is under mortgage and cannot be sold without
obtaining an NOC (No Objection Certificate) from the bank.
Equitable mortgage
- See also: Security interest#Types of security
In an equitable mortgage the lender is secured by taking possession
of all the original title documents of the property and by borrower's
signing a Memorandum of Deposit of Title Deed (MODTD). This document is
an undertaking by the borrower that he/she has deposited the title
documents with the bank with his own wish and will, in order to secure
the financing obtained from the bank.
History
At common law, a mortgage was a conveyance of land that on its face was absolute and conveyed a fee simple estate,
but which was in fact conditional, and would be of no effect if certain
conditions were met — usually, but not necessarily, the repayment of a
debt to the original landowner. Hence the word "mortgage" (a legal term
in French meaning "dead pledge"). The debt was absolute in form, and
unlike a "live pledge" was not conditionally dependent on its repayment
solely from raising and selling crops or livestock or simply giving the
crops and livestock raised on the mortgaged land. The mortgage debt
remained in effect whether or not the land could successfully produce
enough income to repay the debt. In theory, a mortgage required no
further steps to be taken by the creditor, such as acceptance of crops
and livestock in repayment.
The difficulty with this arrangement was that the lender was
absolute owner of the property and could sell it or refuse to reconvey
it to the borrower, who was in a weak position. Increasingly the courts
of equity
began to protect the borrower's interests, so that a borrower came to
have an absolute right to insist on reconveyance on redemption. This
right of the borrower is known as the "equity of redemption".
This arrangement, whereby the lender was in theory the absolute
owner, but in practice had few of the practical rights of ownership,
was seen in many jurisdictions as being awkwardly artificial. By
statute the common law's position was altered so that the mortgagor
would retain ownership, but the mortgagee's rights, such as foreclosure, the power of sale, and the right to take possession, would be protected.
In the United States, those states that have reformed the nature of mortgages in this way are known as lien
states. A similar effect was achieved in England and Wales by the Law
of Property Act 1925, which abolished mortgages by the conveyance of a
fee simple.
Foreclosure and non-recourse lending
In most jurisdictions, a lender may foreclose
on the mortgaged property if certain conditions — principally,
non-payment of the mortgage loan — apply. Subject to local legal
requirements, the property may then be sold. Any amounts received from
the sale (net of costs) are applied to the original debt.
In some jurisdictions, mortgage loans are non-recourse
loans: if the funds recouped from sale of the mortgaged property are
insufficient to cover the outstanding debt, the lender may not have
recourse to the borrower after foreclosure. In other jurisdictions, the
borrower remains responsible for any remaining debt, through a deficiency judgment.
Specific procedures for foreclosure and sale of the mortgaged
property almost always apply, and may be tightly regulated by the
relevant government. In some jurisdictions, foreclosure and sale can
occur quite rapidly, while in others, foreclosure may take many months
or even years. In many countries, the ability of lenders to foreclose
is extremely limited, and mortgage market development has been notably
slower.
At the start of 2008, 5.6% of all mortgages in the United States were delinquent. [3]
By the end of the first quarter that rate had risen, encompassing 6.4%
of residential properties. This number did not include the 2.5% of
homes in foreclosure. [4]
Mortgages in the United States
Types of mortgage instruments
Two types of mortgage instruments are commonly used in the United
States: the mortgage (sometimes called a mortgage deed) and the deed of
trust.[5]
The mortgage
In all but a few states, a mortgage creates a lien on the title to the mortgaged property. Foreclosure
of that lien almost always requires a judicial proceeding declaring the
debt to be due and in default and ordering a sale of the property to
pay the debt.[citation needed]
The deed of trust
The deed of trust is a deed by the borrower to a trustee for the
purposes of securing a debt. In most states, it also merely creates a
lien on the title and not a title transfer, regardless of its terms. It
differs from a mortgage in that, in many states, it can be foreclosed by a non-judicial sale held by the trustee.[6] It is also possible to foreclose them through a judicial proceeding.[citation needed]
Most "mortgages" in California are actually deeds of trust.[7]
The effective difference is that the foreclosure process can be much
faster for a deed of trust than for a mortgage, on the order of 3
months rather than a year. Because the foreclosure does not require
actions by the court the transaction costs can be quite a bit less.[citation needed]
Deeds of trust to secure repayments of debts should not be confused with trust instruments
that are sometimes called deeds of trust but that are used to create
trusts for other purposes, such as estate planning. Though there are
superficial similarities in the form, many states hold deeds of trust
to secure repayment of debts do not create true trust arrangements.[citation needed]
Mortgage lien priority
Except in those few states in the United States that adhere to the title theory of mortgages,[8] either a mortgage or a deed of trust will create a mortgage lien
upon the title to the real property being mortgaged. The lien is said
to "attach" to the title when the mortgage is signed by the mortgagor
and delivered to the mortgagee and the mortgagor receives the funds
whose repayment the mortgage secures. Subject to the requirements of
the recording laws
of the state in which the land is located, this attachment establishes
the priority of the mortgage lien with respect to most other liens[9] on the property's title.[10]
Liens that have attached to the title before the mortgage lien are said
to be senior to, or prior to, the mortgage lien. Those attaching
afterward are said to be junior or subordinate.[11] The purpose of this priority is to establish the order in which lien holders are entitled to foreclose
their liens in an attempt to recover their debts. If there are multiple
mortgage liens on the title to a property and the loan secured by a
first mortgage is paid off, the second mortgage lien will move up in
priority and become the new first mortgage lien on the title.
Documenting this new priority arrangement will require the release of
the mortgage securing the paid off loan.
See also
Notes and references
- ^ Coke, Edward. Commentaries on the Laws of England. “[I]f
he doth not pay, then the Land which is put in pledge upon condition
for the payment of the money, is taken from him for ever, and so dead
to him upon condition, &c. And if he doth pay the money, then the
pledge is dead as to the Tenant”
- ^ a b "Law of Property Act 1925 (c.20) Part III Mortgages, Rentcharges, and Powers of Attorney". Ministry of Justice. Retrieved on 2008-01-30.
- ^ Can the World Stop the Slide?, TIME, February 4, 2008, page 27.
- ^ Kemp, Carolyn. Delinquencies and Foreclosures Increase in Latest MBA National Delinquency Survey. MortgageBankers.org. 5 June 2008. Mortgage Bankers Association. 19 June 2008 <http://www.mortgagebankers.org/NewsandMedia/PressCenter/62936.htm.>
- ^ Kratovil, Robert; Werner, R. (1988). Real Estate Law, 9th, Prentice-Hall, Inc., Sec 20.09. ISBN 0-13-763343-2.
- ^ Kratovil, Robert; Werner, R. (1988). Real Estate Law, 9th, Prentice-Hall, Inc., Sec 20.09(b). ISBN 0-13-763343-2.
- ^ See the discussion of background principles of California real property law in Alliance Mortgage Co. v. Rothwell, 10 Cal. 4th 1226, 1235-1238 (1995).
- ^ Kratovil, Robert; Werner, R. (1981). Modern Mortgage Law and Practice, 2nd, Prentice-Hall, Inc., Sec 1.6. ISBN 9780135957448.
- ^ Exceptions include real estate tax liens and, in most states, mechanic's liens.
- ^ The
failure to record a previously made mortgage may, under some
circumstances, allow a subsequent mortgagee's mortgage to be recognized
as prior in right to the otherwise prior mortgage.
- ^ Of course, the lienholders can agree among themselves to a different priority arrangement through subordination arrangements. See, R. Kratovil and R. Werner Modern Mortgage Law and Practice Chs. 30 & 38 (2nd Ed. Prentice-Hall, Inc.)
Classical
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