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A mortgage is the type of security instrument most often used in connection with loans for the purchase or improvement of real estate. The document is usually recorded in the public record and becomes a lien on the property.
There are two parties to a mortgage: the mortgagor is the property owner and the mortgagee is the lender. (Words ending in "or" denote the party giving, "ee" the one getting.) When the mortgagee loans money to the mortgagor, the mortgagor signs a promissory note for the amount of money borrowed, and "gives" a mortgage to secure the debt. The mortgage is a written instrument that secures the loan by encumbering the title to the property.
In most states there will also be a deed of trust or trust deed executed as a part of the mortgage paperwork. You can review examples of all the documents associated with a mortgage in the RHOL Forms and Agreements Web.
A mortgage requires a contract between two parties, so the conditions contained in the mortgage must be agreed to and sealed by both parties in order for the contract to be valid. Those conditions are likely to include mortgage assignments; assumptions; the lender's ability to declare the mortgage due on any sale of the property, and assignment of rents in the event of default on the note.
Interest rates, terms, fees and closing costs vary widely between lenders so it is always wise to shop for the one that will give you the best deal. The difference between the highest and lowest rate you are quoted could affect your cash flow by substantial amounts.
The traditional roll of local lending institutions and mortgage brokers, has been undergoing a major change since the early 1980s. Now they often act only as agents to create and or service the loans they write, while their long-term mortgages are packaged and sold as investment instruments.
Investors Pay More
Rental property mortgages have historically been higher risk loans, so mortgage insurance underwriters limit the number of non-owner occupied mortgages they will insure for individual borrowers to five. Additionally, real estate investors do not have the interest rates, terms or down payment options that are advertised and available to home buyers.
The argument for demanding higher rates, and down-payments, from investors is usually that homeowners are more likely to sacrifice almost anything to save their home, while investors will walk away from a troubled property. While that may occasionally be true, the primary reason for charging higher rates is that investors are willing to pay them.
Landlords will charge the highest rent they can get, banks are just as willing to make a better profit if they can.
Because underwriters will not accept more than five non-owner occupied properties from any individual, real estate investors need to develop a relationship with a local lender who will keep their paper 'in house".
Lenders are often unwilling to accept the risk of fixing long term interest rates, that's why they sell the mortgages, but they may agree to write Adjustable Rate Mortgages (ARMs) on investment property. Don't be surprised when they demand one or two extra points at closing and a percent or two more on the mortgage.
Types of Mortgage
A fixed rate mortgage is one in which the interest remains the same for the term of the loan. It could be a short-term interest only loan with the entire principle due at the end of the term, a balloon note, or an amortizing loan where each payment includes the interest due and some amount on the principal. The terms for self-amortizing loans usually vary between 15 and 30 years. The shorter-term loans will have a higher monthly payment, but will result in a substantially smaller amount of total interest paid. The longer-term loan will result in a higher total interest paid, but allows a smaller monthly payment, making the loan more affordable or providing a better cash flow for investors. The payment amount is the same for each period, (in the U.S. one month, in Canada every two weeks) so that at the end of the mortgage term the loan will be paid off.
Because interest is collected in arrears, the interest due on a mortgage declines with each payment and the amount going to principal increases. It is impossible for a lender to predict where interest rates will be 10, 20 or 30 years from now, so lenders are likely to quote higher interest rates for a fixed rate long-term mortgage to offset the risk to the lender. Adjustable Rate Mortgages (ARMs) have interest rates that are tied to some kind of financial index, usually U.S. treasury notes. That results in mortgage interest rates that can vary over a specified range, and usually mortgage payments that adjust as well. A portion of the long-term rate risk is transferred to the buyer so the lender is willing to accept lower initial interest rates on the loan. There are a number of additional terms associated with an ARM. The initial interest rate of the mortgage is known as the "start rate", applicable for a specific period determined by the terms of the mortgage. The period of time that is fixed can range from one month to several years. Once this initial period expires, the interest rate can begin to vary, depending on what happens to the interest rate it is tied to. In practice, the rate adjustment frequency varies from monthly to annually. The interest rate will rise, fall or remain the same depending on other long-term rates. The overall change is usually limited annually, and over the life of the loan, by a cap. Typically the annual payment increase cap is around 7.5. Some adjustable rate mortgages have an annual interest rate adjustment cap instead of a payment cap. That sets a limit on the maximum amount of interest rate adjustment. Instead of a payment cap of around 7.5% some ARMs might have a 2% annual interest rate cap. A mortgage with a start rate of 10% can then only grow to 12% at the beginning of the second year. ARMs typically have a lifetime interest rate cap as well, which sets the absolute maximum interest rate allowed for the mortgage. If the financial index to which the interest rate is tied reaches the cap, the mortgage basically becomes a fixed-rate mortgage until the financial index drops enough for the mortgage interest rate to drop below the rate cap. There is usually a minimum interest rate required by the lender as well. When the interest rate changes without like changes in monthly payments, it is possible for the loan amount to actually increase as the deficit in the payment amount is added to the principal. This is known as negative amortization. Competition among lenders has resulted in a great many real estate financing options. The fixed-rate mortgage is fairly straightforward and the conservative selection for both borrowers and lenders. Nothing should change during the 15 to 30 year term, except for the property taxes and insurance amount that may be collected in the payment. ARMs can vary in many different ways and lenders offer a number of different options to deal with changes in the interest rate index. In addition to an annual rate adjustment, some lenders offer a fixed rate for a specified period of time, like five to seven years. At the end of that initial period the rate can vary annually. Unlike fixed rate mortgages, most ARMs are assumable. That may be a real benefit to your future buyer if you do not intend to own the property long term. Choosing between a fixed and variable/adjustable rate mortgage can be difficult and depends somewhat on your investment comfort level. If security and predictability are most important to you, then the security of a fixed payment long-term loan will be attractive. If you expect to sell within the next five years or are willing to gamble that interest rates to go down, the variable/adjustable rate mortgage could be a much better deal. There are many real estate lenders to choose from. They include credit unions, savings and loan associations, commercial banks, mortgage bankers and mortgage brokers. Each type of lender will have their own policies and rules, but all are in the business of loaning money. You may find one lender that will not qualify you for a loan while another down the street will loan you more money than you really need. Shop around and do not be intimidated by the lender. See our pages on Financing Real Estate.
Escrow or Impound Accounts
Property taxes become a lien on real estate when past due and therefore affect the security given for a mortgage loan. Causality and flood insurance are also important to a lender because their security could be damaged or destroyed. Consequently, many lenders require that a portion of the cost of property taxes and insurance be collected with each mortgage payment and placed in special account to pay the bills as they become due. The taxes and insurance portion may, therefore, affect the amount of a fixed term payment as property values rise and insurance rates fluctuate. That portion is normally adjusted once each year. See Shopping for Insurance
RHOL Members can Download
There are many good computer programs available to help analyze loan variables. Some of them are available to RHOL Members from our Download Page, including: Loan Calculator. It includes six loan and interest calculation programs for regular loans, interest due/calendar math, remaining balance, accelerated payment, balloon payment, and refinancing a current obligation.
Data is entered into straightforward, multi-optioned forms. Examples and a good help system are provided to assist you. The refinancing analysis system provides a clearly written conclusion with sound advice. This latest version adds amortization schedules with five different methods, as well as ease-of-use enhancements. Multiple copies of each module can be run for side-by-side comparisons, and results can be copied or printed.
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