Monday, September 05, 2005

Some history on mortgages

A mortgage (literal translation: "death pledge") is a device developed in the common law world, whereby the ownership of property is passed from one person -- the mortgagor -- to another -- the mortgagee in return for the loan of money. The mortgagee is prevented from exercising their rights of ownership by the rules of equity so long as the interest on the loan is paid.
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Historically this distinguished a mortgage from other legal devices such as a lien, charge or pledge, but in most common law jurisdictions the operations of mortgages has been changed so that these concepts have merged to a greater or lesser extent.
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In modern society it is used as a method by which individuals or businesses can buy residential or commercial property without paying the full value upfront.
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The borrower (also called the mortgagor) uses a mortgage to pledge real property to the lender (also called the mortgagee) as security against the debt (also called hypothecation) for the rest of the value of the property. In legal terms, the creation of a mortgage gives the legal title of the land to the mortgagee and an equitable title (called "equity of redemption") to the mortgagor. The legal title, however, only exists as a security for a debt and does not convey any title or powers associated with real property.
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To protect the lender, a mortgage is recorded in the public records creating a lien (when there are multiple liens, order of recording determines priority). 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 the lien of the mortgage is prior to anyone else's claim. 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.
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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 not met --- usually, but not necessarily, the repayment of a debt to the original landowner. Hence the word "mortgage," Law French for "dead pledge;" that is, it was absolute in form, and unlike a "live gage", was not conditionally dependent on its repayment solely from raising and selling crops or livestock, or of simply giving the fruits of crops and livestock coming from the land that was mortgaged. 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, for repayment.
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In many U.S. states, however, a mortgage has been converted by statute to a device for creating a security interest in land. When the landowner fails to perform on the obligation secured by the mortgage, the mortgage holder may file a foreclosure to cause the property to be sold at auction, usually by the sheriff.
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Mortgage lending is a major category of the business of finance in the United States of America. Mortgages are commercial paper and can be conveyed and assigned freely to other holders. In the U.S., the Federal Housing Administration administers the programs colloquially known as "Ginnie Mae", Fannie Mae and "Freddie Mac" (also known as the GSEs or government sponsored entities) to foster mortgage lending and thus to encourage home ownership and construction. These programs work by buying a large number of mortgages from banks and issuing (at a slightly lower interest rate) "mortgage-backed bonds" to investors known as MBS or Mortgage Backed Securities.
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This allows the banks to quickly relend the money to other borrowers (including in the form of mortgages) and thereby to create more mortgages than the banks could with the amount they have on deposit. This in turn allows the public to use these mortgages to purchase homes, something the government wishes to encourage. The investors, meanwhile, gain low-risk income at a higher interest rate (essentially the mortgage rate, minus the cuts of the bank and GSE) than they could gain from most other bonds.
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Securitization is a momentous change in the way that mortgage bond markets function which has grown rapidly in the last 10 years as a result of the wider dissemination of technology in the mortgage lending world. For borrowers with superior credit, government loans and ideal profiles, this securitization keeps rates almost artificially low, since the pools of funds used to create new loans can be refreshed more quickly than in years past, allowing for more rapid outflow of capital from investors to borrowers without as many personal business ties as the past.
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For all of you who are wondering, this is how China actually owns most of the United States' real estate. Their government is buying our Mortgage Backed Securities, thereby taming Chinese and American inflation.
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In the USA, the process by which a mortgage is secured by a borrower is called origination. This involves the borrower submitting an application and documentation related to the his/her financial history to the underwriter. Many banks now offer "no-doc" or "low-doc" loans in which the borrower is required to submit only minimal financial information. These loans carry a slightly higher interest rate (perhaps 0.25% to 0.50% higher) and are available only to borrowers with excellent credit.
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Sometimes, a third party is involved, such as a mortgage broker. This entity takes the borrower's information and reviews a number of lenders, selecting the ones that will best meet the needs of the customer.
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Loans are often sold on the open market to larger investors by the originating mortgage company. Many of the guidelines that they follow are suited to satisfy investors. When a company is VERY PICKY, it means that Most Likely, your loan is going to be sold "upstream" to an investor within three months of origination.
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Additionally, there is a whole class of licensing in Florida (and many functional companies elsewhere that act in this manner) called a Correspondent Lender. These companies exist to sell closed loans, and accept the risks for issuing them. They often offer niche loans at higher prices, that the Investor does not wish to originate.