What Exactly is a Contract of Mortgage?
Contract of Mortgage is defined under section 58 of the Transfer of Property Act, as "The transfer of an interest in specific immovable property for the purpose of securing the payment of money advanced or to be advanced by way of loan an existing or future debt, or the performance of an engagement, is called a "mortgage"". It can be understood as a contract by which the owner of a property transfers his rights in a property on the promise that he will repay the amount of loan taken by him with interest. Hence it is a contract where a person borrows a sum of money with interest and against that the land or property is given as security and if the person is not able to pay back the loan, the lender can sell the land to recover his money. This contract gives the mortgagee interest in the property. The relationship between a Mortgagor and a Mortagee is that of Debtors and Creditors. A contract of mortgage arises when the owner of a property transfers a right to someone in order that such person may recover a debt or performance of an obligation contained in the document. Thus the consideration for a mortgage is to secure the payment of money. Parties: A contract of mortgage is made between two parties: 1. Mortgagor – who borrows money and gives a property as a security against it. 2. Mortgagee – who lends money and takes a property as a security against the loan given . A contract of Mortgage is an Agreement between the mortgagor and mortgagee. Various Kinds of Mortgages: There are basically 5 kinds of Mortgages. They are: 1. Mortgage by ‘Conditional Sale’. 2. Mortgage by ‘Mortgage Charge’. 3. Mortgage by ‘Assignment of Rights’. 4. Mortgage by ‘Deposit Title Deeds’. 5. Mortgage by ‘Legal Mortgage’. In an Unofficial Sense, Mortgage means, the loan given by the bank against the security of the property of the ‘Mortgagor’. Essentially the Contract of Mortgage means the transfer of interest, i.e. the property is transferred to the ‘Mortgagee’. Hence the property will not form a part of the estate of ‘mortgagor,’ after the mortgagor repays the loan to the mortgagee, the property shall become his own again. The mortgage is said to be conditional when the document express the whole consideration or part of it to have been received, on condition that the sale of the property would be effected if the mortgager fails to pay. Mortgage by Mortgage Charge: As the name suggests, this is the creation of a charge on the property which is already mortgaged. In this case, the mortgage may be either registered or unregistered. The transfer of property Act, 1882 gives importance to registration of mortgage much more than it does to unregistered mortgage.
Crucial Components of a Mortgage Contract
Mortgage contracts, though sometimes confusing, are actually quite simple. Lenders do their best to make them complex, but the basic parts of a mortgage contract are the same throughout the industry. A mortgage lender wants you to repay the loan. They want you to pay it according to the terms and schedule agreed upon when you signed the mortgage.
The major parts of a mortgage are the principal amount, the interest rate, the payment period (years to repay the loan), and when payments will be made (monthly, bi-weekly, etc.). These elements of a mortgage are very important for both lenders and borrowers. A lender wants to know that they are lending a reasonable amount to you for a reasonable period to be repaid at a fair interest rate. A borrower also wants to know that they are taking out a reasonable amount to borrow at a reasonable interest rate so that they can pay it back in a reasonable period of time.
Many times, a mortgage loan will contain an amortization schedule with complete cost information and payment plans, including a full payment schedule and listing of all estimated monthly payments for the life of the loan. An important item to note is that these charts are not guarantees for future payments. Just because the chart shows a certain number of payments, does not mean that you will be required to make those payments. Some lenders may offer to allow you to make bi-monthly payments (such as per month or every other week). If you choose this plan, your lender will expect you to keep that plan.
Remember, when it comes to a mortgage contract, you have a contract to follow.
Different Types of Mortgage Contracts
A mortgage contract is a legally binding agreement between a borrower and a lender on the terms of the loan to be taken to finance a home. There are several types of mortgage contracts, the most popular being a fixed-rate mortgage and an adjustable-rate mortgage.
Most first-time homebuyers who seek financing choose a fixed-rate mortgage contract. This loan requires the borrower to pay the same interest rate on the principal for the entire length of the loan, usually 30 years. One of the reasons fixed-rate mortgages are popular is that they
While fixed-rate loans are stable and easy to budget around, there are a few downsides. Although the borrower may be able to refinance to a lower interest rate at a different lending institution, it is not likely that the borrower can reduce the principal amount of the loan on the existing mortgage contract. This can be a problem particularly if property values have decreased and the borrower cannot sell the house for what is owed to the lender.
Adjustable-rate mortgages (ARMs) are another type of mortgage contract where the loan interest rate is tied to a financial index, changing at certain milestone periods specified in the contract. ARMs have many variants, but instances typically include:
Not all ARMs have caps on the total amount of interest that can be charged during the life of the loan, so watch out. If there is no cap, your monthly payment could change drastically if the index rate went up 5 or more points.
Keeping a close eye on the ups and downs of interest rates is crucial with ARMs. If the interest rates go down, the index rate will follow, but if the interest rates go up, so will your monthly payments. For this reason, ARMs are often tied to short-term leases and are popular with investors who plan to flip or rent out properties. If the property is sold before the end of the term, the ARM disappears.
Interest-only loans (IOs) are primarily given to investors, not residential borrowers. Since a loan is secured based on the projected rise in the property value, lenders won’t agree to the loan unless they are confident property values will increase. Since no mortgage is ever a guarantee, lenders still charge an interest rate to account for that risk. IOs are generally given in situations where property prices are expected to increase at a predictable rate over a set period of time.
Interest-only loans are exactly as they sound: you only pay back the interest on the loan, not the principal, for a 3-5 year period. With a small monthly payment, investors can put that money toward redeveloping or renting out a piece of real estate. After three to five years, the loan converts to a typical fixed-rate mortgage contract, requiring the borrower to pay back principal and remaining interest.
The popularity of a mortgage contract ultimately depends on whether you’re making an investment or a permanent residence purchase.
The Legal Process of Obtaining a Contract of Mortgage
The process of obtaining a mortgage contract begins before the homebuyer even finds a property. Early on in the house-hunting process, the potential buyer will at least connect with the lender for a basic discussion about expectations, interest rates, credit scores, and likely loan amounts. This is the time to ask the lender how it plans to handle the mortgage process, and to learn whether it has any affiliated companies that it encourages or requires borrowers to use.
The next step for some buyers is pre-approval for a loan. Pre-approval is more than a pre-qualification; it is a commitment to processing the loan for closing. The lender sends an application to an underwriter, who reviews the application to determine whether the buyer is financially able to repay the loan, including checking credit, employment, income and savings. Pre-approval provides the buyer with a definitive "green like" to offer a seller.
A major decision is whether to waive the mortgage contingency, to assist in the seller’s ability to close quickly. Waiving the mortgage contingency is risky, as buyers easily can lose their deposit if they cannot obtain a mortgage.
After a buyer’s offer is accepted, the mortgage company will provide a list of documents needed to finalize the process. The buyer must provide, among other items: 1) paystubs covering the last 30 days; 2) W-2 forms for the past two years; 3) tax returns for the past two years, along with signed copies of an IRS Form 4506-T, Request for Transcript of Tax Return; 4) copies of bank statements for the previous three months (all pages); 5) proof of additional assets; and 6) photo ID (i.e., driver’s license).
At this point the mortgage company or lender will conduct yield maintenance (which breaks the bond between the ropes of money and the owner of the money), checking the settlement statement, and having an appraisal done. It will also send the borrower a loan estimate which sets forth the terms of the loan, including loan amount, interest rate, and overall costs.
The closing document review process typically will happen one week prior to the closing. The specific documents that a closing attorney reviews should be set forth in the retainer letter, which usually includes a list of all the documents that the buyer will be responsible for reviewing, even if the attorney will be the one to discuss them at the close. The attorney typically will review the title policy, closing disclosure, warranty deed, mortgage deed, bill of sale, and note. At closing, the borrower must sign those documents and make the required down payment.
Typical Provisions of a Mortgage Contract
Mortgage contracts, typically referred to as "mortgages," are a contract between the lender and a home buyer. The lender agrees to provide a sum of money at an interest rate which the buyer promises to pay back in future monthly payments. In some cases the lender also agrees to disburse funds for property taxes, homeowner’s insurance, and mortgage insurance. While each mortgage contract is different, certain clauses are quite common.
Acceleration Clauses
Perhaps the most feared clause in a mortgage contract is the acceleration clause. This provision gives the lender the right to accelerate the due date of the remaining principal if the borrower is in default. Default could be the result of non-payment of a monthly installment or the result of other problems in making the loan. Once the lender has terminated the contract for default, the entire amount of principal, interest and costs shall be immediately due and payable.
Prepayment Penalty Clauses
A prepayment penalty clause provides that the borrower will be required to pay a large penalty if the loan is paid off within a few years of making the loan. While such penalties are not often used in conventional loans , they do come up where there are large origination or closing costs to be recouped. These types of penalties may allow a borrower to refinance a loan with little cost.
Escrow Requirements
While paying for property taxes and insurance directly each month would be a burden to many homeowners, most mortgage contracts make the payment of property taxes and home insurance the responsibility of the lender. The borrower, in exchange for making monthly payments on the loan itself, will pay the lender an additional monthly payment that will be held in escrow to pay for insurance, taxes, and any other costs.
If the borrower defaults and ends up with a tax foreclosure or a home insurance claim, the lender is protected by the escrow payments to avoid any claims of equitable lien rights between the borrower and the lender. When the lender has to make those payments, the borrower can be billed separately for those costs, or they may be added to the amount due on the mortgage.
These are just a few of the clauses that may be contained in a mortgage contract. Any homebuyer is well advised to have an attorney review the mortgage contract prior to signing the loan.
Your Rights and Obligations under a Mortgage Contract
Both the borrower and the lender have rights and responsibilities under a mortgage contract. For example, default by the borrower means the lender has a right to foreclose on the property. The consequences of a borrower defaulting on their mortgage can be severe. Most mortgages allow for late fees and allow the lender to pursue collections actions against the borrower. However, a lender cannot strip the borrower of their property without going through a proper foreclosure process first. In most cases, the lender has to initiate a judicial foreclosure in court, but non-judicial foreclosures are also permitted in some states.
Even when loans are securitized or bundled and sold off, the lender may take back the property if the debtor is behind on his or her payments. A lender can liquidate the assets to recoup losses from foreclosure, but they cannot take the home away simply for missed mortgage payments. Homeowners do, however, have the right to walk away from their mortgage in many states. During this process, an underwater homeowner can suffer from negative credit implications as the bank may not always have balance forgiveness policies in place.
Tips for Securing More Favorable Mortgage Contract Terms
There are several components of a mortgage contract that can be negotiated to secure more favorable terms and conditions. Broadly speaking, greatest financial advantages can often be achieved by negotiating available mortgage interest rates, fees or points on the mortgage, loan-to-value ratios, and lien priority. However, homebuyers should also keep in mind that the long-term financial effects of a mortgage contract, and the degree to which it may lessen current cash flows, may be more effectively addressed through the negotiation of basic loan features such as early redemption pre-payments, repayment schedules and amortization periods.
Homebuyers can generally negotiate the interest rate with their lenders on a variety of bases. For example, a fixed-rate mortgage is generally less risky than an adjustable-rate mortgage, and, as such, a homebuyer can often utilize this most basic of lending risk mitigation strategies to achieve a more favorable interest rate . Similarly, although not without risk, making additional points or fees up front can often help a homebuyer reduce the interest rate on loan as well as the value of a real estate mortgage lien, since a mortgage with less loan equity will assume lower risk for the lender who issued it.
Another important consideration when purchasing a home is the possibility of a smaller home or purchased property. While the statistics vary, a small percentage of homebuyers are known to experience a decrease in their overall net worth after a home purchase. While this is almost always a function of specific personal financial circumstances, minimizing the amount of the loan or securing a favorable interest rate can help offset these types of financial risks.